Let's Get Down to Business...

Fiscal Policy comes in Two Flavors: Which one works?

The federal government is using both fiscal policy and monetary policy to stimulate consumer and business demand and end the current recession. If things work as planned, positive economic growth will be restored (how long this will take is another problem for another day).

Fiscal policy, as we've discussed, can have two approaches. The one getting most of our recent attention is "stimulus spending." It is based on a theory that properly-directed government expenditures will have a "multiplier" of greater than one. In other words, one dollar of government spending will produce more than one dollar of gross domestic product.

The other "flavor" of fiscal policy is tax reductions. The idea here is lower taxes mean more disposable income for consumers who will spend and invest more thereby boosting economic growth and helping end the recession.

Surprisingly, there isn't much empirical evidence to support using one or both of these tools. The ideas have been around for a long time as theories but there aren't many studies that tell us which works best.

Here's a recent article from the Wall Street Journal reporting some research done on this question by a Harvard Economics Professor: Download Stimulus Spending Doesn't Work.

I won't spoil the story other than to point out that (1) the unemployment rate during the Great Depression was consistently around 25% and (2) lowering income taxes when personal and corporate incomes are falling is a double-whammy for local, state and federal governments.

Yield Curves "Rate" your "Interest"

Understanding Monetary Policy and Interest Rates becomes easier when the ideas are illustrated.   A great way to do that is by looking at some Yield Curves.

Yield curves are nothing more than plots of interest rates as of a specified time based on maturities. 

The "based on maturities" part of that definition gets clearer if you think about "money markets" being where different financial products are bought and sold.

Helpful Note:  Financial markets deal in dozens of different bonds, paper, bills, instruments and notes.  It can get overwhelming.  Keep it simple by remembering they're all just products.  How they differ from one another isn't important.  Every market, including money markets, has buyers (someone wanting a financial product that pays a specified amount on a certain future date) and sellers (someone providing the financial product that will do that).

One of the ways financial products differ from one another is by their term.  One product you buy today might not pay-off for one year while another might not pay-off for 20 years (these time periods are called the product's "term").

Obviously the "price" you pay for a product with a one-year term will not be the same as what you pay for a product with a 20-year term.  And what makes them different is the interest rate for one won't be the same as the interest rate for the other. 

Things get very interesting (and even exciting) when you think about the relationships between these differences and how they change over time.  That's when Yield Curves become your new "best friend!"

Economic Indicators for Small Businesses

Most of the indicators used by our friends, the Economists, don't work well for Business Managers. Global statistics or information that doesn't relate to our customers and suppliers isn't helpful.

Here's a recent article from the Wall Street Journal that suggests how small businesses can use the Unemployment Rate (look at local trends and rates). More interesting, it introduces you to four new (aren't you excited?) measures that give small business decision-makers a lot of what they need to know. Enjoy.

• Download Small Business Indicators

Feedback - Give it early and often

It's important that we communicate with one another about how you're doing in the course.  All too often, evaluations come at the end of a course when it's too late to make mid-course corrections.

How about doing things different and maybe better?

Here's a link to a Confidential Survey where you can give me some feedback on what's working or not working for you:  Click to Give Feedback

Your feedback is confidential.  I'm the only one who will see it.  Access to your feedback is password protected.

Your feedback can also be anonymous if you want.  If you want me to contact you, or know who you are, leave your name and how to contact you.  Otherwise, your feedback will be anonymous if you want it to be.

Let me know early and often how things are going.  Thanks for your help.

How Big is "Too Big" in the "Too Big to Fail" Debate?

Most of the Financial Reform debate has focused on what should we do when (not if) a financial banking behemoth fails.

It's argued that something will need to be done because doing nothing risks "systemic failure," which is something so bad that the entire economy might fail unless something is done.

Is that the right question? What about asking instead, "How big is 'too big'?" Why do we need financial institutions so big that they might drag down the entire economy if they fail?

What's the "right size" for banks? Shouldn't they be only big enough to serve their local economy without risking the national economy if they fail? But what's a "local economy?"

Answering those questions isn't easy. It requires first understanding the boundaries of a "local economy." Do we really need "global" financial institutions? Don't banks have to be bigger than the neighborhood coffee shop in order to have the financial clout to make something happen? What is that "right size?"

Here's a video that uses some fancy algorithms to give you a peek at how to answer those questions. Enjoy.

How can "Economics Stuff" be useful to Business Managers?

Success in business is all about well-informed decision-making.  To be good at that requires having information that's "relevant" and "reliable."  This doesn't mean having mountains of data or information that's interesting, but not "on-topic."

Figuring out where to get the "right" kinds of information and how to make it useful is a key focus for our course's Week Number Two. 

Before going any further, here are my Lecture Notes and PowerPoint Presentation for this week:

Download Assessing the Business Environment (Week 2) - Lecture Notes

And one place to start might be the "external environment" where our business will (hopefully) profitably thrive.

 

The Economists are the masters of this external domain.  Part of your business education requires spending time in their "macroeconomic" and "microeconomic" worlds.  But are the Economists' explanations of how things work (or supposed to work) useful to business managers?  Can you take what they're saying and use it for decision-making?  Or do you need to "translate" economic data into useful business decision-making information?

Let's see if we can sort this out by looking at some of the key terms from this week's textbook readings...

 

More than you ever wanted to know about the Laws of Demand and Supply

As we discussed, the world of Macroeconomics, like the worlds of Physics and Chemistry, has laws that govern how things will happen.

The three that you need to know for our course, for your economics courses and future enjoyment are:

1. The Law of Demand: There is an Inverse Relationship between a Product's Price and the Quantity of that product that will be Demanded. Generally, more quantity will be demanded when prices are lower.
2. The Law of Supply: There is a Direct Relationship between a Product's Price and the Quantity of that product that will be Supplied. Generally, producers will supply greater quantities as prices increase.
3. The Law of Equilibrium Price: For all markets, there is an Equilibrium Price where the market Clears. Generally, a market's Equilibrium Price balances the quantity of a product supplied with the quantity demanded and there is no unsatisfied demand or no surplus or inadequate production.

Download this discussion of how markets operate in the world of Macroeconomics. It discusses - complete with graphs - how all this works. These are essential concepts that will need to be mastered as part of your business education. Download Macroeconomics' Laws of Demand and Supply

Second Week's Study Guide

 

Here's the Study Guide for our Course's Second Week: Download Second Week Study Guide

Also review all the Blog Posts for Week 2 (Economic Conditions: Business Management's Perspective).

What if we would have looked at Employment instead of GDP?

As you've learned, the "classic" and easiest-to-remember definition for a recession is "two consecutive quarters of decline in real GDP."

According to the Bureau of Economic Analysis, the current recession started during the Third Quarter of 2008 (GDP declined during the First Quarter of 2008, increased in the Second Quarter but then declined for 2008's Third and Fourth Quarters).

But weren't red flags flying long before the middle of 2008? Did relying on the classic definition of a recession cause us not to take seriously what was happening? Could we have reacted faster and better if another measure of our economic health had been used?

The National Bureau of Economic Research (NBER) is a private, non-profit, nonpartisan research organization that disseminates "unbiased economic research." Founded in 1920, its membership includes 16 of the 31 Americans who have been awarded the Nobel Prize in Economics and six of the past Chairs of the President's Council of Economic Advisers.

The NBER has come up with a different definition for the start (and end) of a recession,

"A significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches a trough. Between trough and peak, the economy is in an expansion."

Using this definition, the NBER weighs changes in production and employment more than GDP changes. Payroll employment reached a peak in December 2007 and, according to the Bureau of Labor Statistics, has declined every month since then.

This approach led the NBER to declare the US economy in a recession beginning in December 2007, fully six months before the classic definition was triggered. Here's a copy of that analysis for your reading enjoyment: Download NBER Determination of Recession (December 2007).

Would starting "anti-recession" measures six months sooner have made a difference? Would we have spent less in stimulus measures? Would monetary policy have been more effective? Is this a variation of the ages-old problem of whether the right questions were being asked rather than whether the answers were correct?

On September 20, 2010, the NBER announced their opinion the the economy had "troughed" and the longest recession since the Great Depression was over as of June 2009, over 15 months ago. Here's copy of their analysis: Download Sept 2010 NBER End of Recession Declaration. For policy makers, this information can't be very helpful, coming so late. But the larger question is whether anything has changed over the past 15 months: things may not be getting any worse, but are they getting any better?