An Obscure National Holiday

I was informed earlier today that today is, in fact, national underwear day.   That said, here is a piece I wrote on life-cycle consumption not too long ago:

Back in the day, Modigliani and Brumberg (from their perches in Urbana-Champaign!) posited that individuals smooth out their consumption over the course of their lifetimes. In other words, total individual consumption expenditures are pretty stable, or smooth, from year-to-year, rather than having individuals curb consumption in one year to pay for big expenditures in the next. The big-picture implication is that individuals base their consumption spending on their expectations of lifetime earnings.  So, if I expect to make a lot of money years from now, I will spend at higher levels now, even if I don’t have it yet. As a result, the young and the old spend more than they make, whereas the middle aged make more than they spend.

The Modigliani and Brumberg work is now known as the Life Cycle Hypothesis, and it is a seminal contribution for a number of reasons.  First, it is a micro model that has significant macro implications –aggregate consumption depends on (expected) lifetime income, not current income.  It also implies that government deficits are a source of fiscal “drag” on economic growth.  You can check out more on Modigliani and his contributions at The New Palgrave Dictionary of Economics (available at campus IP addresses; otherwise, Google it).

Even if people spend the same total amount of money every year, however,  they will probably be some variation in the items they actually spend it on.  And empirically, of course, this turns out to be the case. Exhibit A: The Atlantic Monthlyhas a fascinating set of figures showing how U.S. consumer spending on various goods and services ranging from booze and smokes to lawn and garden services to men’s furs vary by the age of the consumer.

Presented without comment
Send Grandpa some new drawers

The figures are instructive.

First off, it appears that men pour increasing amounts of money into their undergarments as they age, reaching “peak underwear” at around age 50.  The average male aged 45-54 will drop about $120 on his drawers during that ten-year stretch. After that, underwear spending falls like a stone, and by age 75 or 80 it appears that most men are only spending a couple bucks a year on those closest to them.

At the same time, however, there is a decided uptick in spending on sleepwear/loungewear. I wonder what’s going on?  (Seems like a job for the Economic Naturalist).

In addition to these brief insights, the graphs seem to corroborate some intuition about how spending changes. For example, it seems that people in their late 20s and early 30s start dropping money on childcare services, which temporarily cuts into the amount spent going out boozing. I guess kids and the nightlife are substitutes, not complements.

It is also noteworthy and possibly surprising that 70-year olds spend as much on the sauce as 20-year olds do.

Or, perhaps that isn’t surprising.

As a bonus, some clever interns at The Atlantic have peppered each graph’s url with sometimes amusing, sometimes trenchant, and sometimes bordering on subversive commentary.

Well played all around.

A Second Globalization Features The Great Convergence

In previous blog postings (here and here), I have addressed some of the key myths regarding international trade as well as the difficulties in determining whether U.S. exchange rates are over, under, or fairly valued.  This posting addresses how the forces that drive globalization have changed and so has the distribution of income (in both global and advanced country terms.)  Richard Baldwin’s new book The Great Convergence suggests that a major change in the forces of globalization took place around 1990.  He divides economic history into three broad periods: pre-globalization (until 1820), globalization I (1820 to 1990), and globalization II (from 1990 to the present.)

The graphic above (from a recent Baldwin’s presentation)  displays the three primary forces that affect the magnitude and character of globalization. For further analysis including Milanovic’s “elephant” chart on the global distribution of income, see the full posting here.



Are U.S. Exchange Rates Too High, Too Low, or Just Right?

Currency exchanges rates between any two countries are determined by a variety of factors including their balance of trade and payments, capital flows (both restricted and unrestricted), and monetary policies.  In a recent posting on Conversable Economics, Timothy Taylor argued that “all exchange rates are bad” (meaning that they generate some negative consequences.)  Although this posting does not take issue with Taylor’s arguments, I conclude that there is no one optimal set of exchange rates, since for any given set, there will be winners and losers, and trade-offs among policy objectives must be made. In short, there is no unique way to determine which exchange rate between countries is “just right.”

Exchange rate policy and monetary policy are intrinsically linked.  Countries face what has been called the “Impossible Trinity” or “Trilemma”; they can only choose two of the following: independent monetary policy (setting short term domestic interest rates), fixed exchange rates, and open capital markets.  Thus, a country’s desire to float, fix, manage, or abandon how the price of its currency relates to others depends critically on its views toward monetary policy and the flow of capital into and out of the country. Stated differently, to some extent, all countries (including the U.S.) manipulate their exchange rates by the judgments they make about the trade-offs among the three choices.

Tim Taylor argues that all exchange rates have some negative consequences:

  • If they are too low, they hurt net importers.
  • If they are too high, they discourage foreign direct investment and net exporters.
  • If the rates are too volatile, then the increased uncertainty will reduce economic activity.
  • If they are too stable, they can easily deviate sharply from what is needed to balance supply and demand for currencies.

As Taylor puts it, “the bottom line is clear as mud.  Exchange rates are bad if they move higher or lower, or moving, or stable.”

For more detail including attempts to empirically answer the question for the U.S. posed in the title go here.

The Death of the Great Economists

The latest to pass away is Kenneth Arrow, who by any and all accounts was a genius.   A Fine Theorem tells us what we already know, that “Arrow is so influential, in some many areas of economics, that it is simply impossible to discuss his contributions in a single post.”

These contributions, of course, include work on social choice theory (Arrow’s Impossibility Theorem), general equilibrium theory, and innovation, and off the top of my head I can point to work on health care, organizational theory, quasi-option values, and a bunch of other stuff.   Truly remarkable.   Here is the New York Times obituary.

Meanwhile, the profession has also recently lost Thomas Schelling (2016), Douglass North (2015), John Nash (2015), Gary Becker (2014), Ronald Coase (2013), and Elinor Ostrom (2012).   You could learn a lot in a little while just reading the obits on these Nobel Prize winners.

*********** Tentative 2017-18 Schedule

100 Intro Gerard MWF 9:50
211 In Pursuit of Innovation Galambos TR 12:30
271 Public Economics & Friends Gerard MWF 1:50
300 Intermediate Micro Galambos MTWF 8:30
300 Intermediate Micro Galambos MWF 12:30 T 8:30
420 Money & Montetary Policy Finkler TR 9
481 Advanced Econometrics & Modeling Lhost MWF1:50


100 Intro Caruthers MWF 1:50
205 Introduction to International Economics Caruthers MWF 11:10
225 Decision Theory Galambos MWF 1:50
380 Econometrics Lhost MTWR 9:50
380 Econometrics Lhost MTWR 3:10
421 Investments Finkler TR 9
495 Topics: Institutions & Organizations Gerard MWF 9:50
601 Senior Experience: Reading Galambos T 12:30
602 Senior Experience: Research Lhost R 12:30


100 Intro Gerard MWF 11:10
280 Environmental Economics Gerard TR 12:30
295 Topics in Finance Vaughn MWF 12:20
320 Intermediate Macroeconomics Caruthers MTWR 9:50
320 Intermediate Macroeconomics Caruthers MTWR 3:10
405 Econ of Innovation & Entrepreneurship Galambos MWF 8:30
410 Advanced Game Theory & Applications Galambos MWF 11:10

Economics Colloquia, Winter 2017: Mark Your Calendars

We have a number of excellent talks scheduled for this term that should be of interest to our majors.   Indiana University appears to be well represented.   Each of these talks is at 4:30 in Wriston Auditorium.

Thursday, February 16, 4:30 p.m., Wriston Auditorium

Deal (with) the Burn:  The Political Economy of U.S. Wildfire Management.
Dean Lueck
Ostrom Workshop and Department of Economics
Indiana University

Friday, February 17, 4:30 p.m.    Wriston Auditorium  (Senior Experience speaker)

Seven Secrets of Germany: Economic Resilience in an Era of Global Turbulence
David Audretsch
School of Public and Environmental Affairs
Indiana University

Thursday, March 2, 4:30 p.m.    Wriston Auditorium (Cancelled)

The Brazil Economy in Transition:  Beliefs, Leadership, and Institutional Change
Lee Alston
Ostrom Workshop and Department of Economics
Indiana University

Alston’s NBER paper is here, accessible on LU campus.

Human vs. Digital Labor: Will The Results This Time Be Different?

Since the industrial revolution in England in the 19th century, many policy makers and the public at large have been concerned about the effects of automation on jobs.  For example in 1961, Time magazine published a provocative article entitled “The Automation Jobless,” which posited that efficient machines and productivity improvement would eliminate many low and semi-skilled jobs. As the figure below illustrates, private employment paralleled the growth in labor productivity (in the US) until the turn of the century/ millennium.


Is this time different?  Has the age of technological unemployment arrived?  In their first book on this topic, Race Against the Machine (RAM 2011), Erik Brynjolfsson & Andrew McAfee (B & M) argue that until the 1980s, as shown above, technological improvement and workers’ incomes grew together .  In RAM, they opine we can again bring these two paths together; however, we must equip our labor force with skills to use these technological developments as we have done in the past.

In a second book (2MA, 2014), The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies, B & M offer a more nuanced view. They argue that we should be grateful for the improvements brought forth by technology; however, we need serious policy changes, both short term and long term, to avoid further polarization of the labor force and an increased widening of the distribution of incomes.  They argue as follows:

Technological progress is going to leave behind some people, perhaps even a lot of people, as it races ahead.  As we’ll demonstrate, there’s never been a better time to be a worker with special skills or the right education, because these people can use technology to create and capture value.  However, there’s never been a worse time to be a worker with only ‘ordinary’ skills and abilities to offer, because computers, robots, and other digital technologies are acquiring these skills and abilities at an extraordinary rate.”

For a short version of 2MA, read “The Great Decoupling: An Interview with Erik Brynjolfsson and Andrew McAfee” in the Harvard Business Review (June 2015) or watch and listen to Andrew McAfee’s talk on 2MA. To read more about 2MA, go here.

Incentives Matter But So Does Context

Economist Steven Landsburg famously claimed that economics can be defined in two words: “incentives matter.”  For Landsburg, all else is commentary.  In a 2013 book entitled The Why Axis, Uri Gneezy and John List explore in detail how incentives matter.  Characterizing economics as a behavioral science, they seek to understand what affects individual behavior based on exploring various incentives and contexts.  In particular, they use field experiments to illuminate which incentives matter and how through examples drawn from a number of policy areas including child day care, school performance, charitable giving, gender-related compensation, and health care.  For more including a few examples, go here.

Into the darkness they go, the wise and the lovely

Those of you who are acquainted with my writing on this blog probably know that (a) I study mortality risks, and (b) I sometimes comment on how these risks change when the clocks spring forward and fall backward.   This fall is no exception, as I have a piece in the venerable Costco Connectionmaking the case that maybe keeping Daylight Saving Time as is wouldn’t be the worst thing to happen to the world.  (I could have made the case the other way, as the policy decision here is very unclear, which tends to favor the status quo).

As per usual, the the remarkable site shows us what’s at stake here in Appleton.  The break in the series starting in month 11 is upon us:

The Appleton Day

What does this mean for you?  Well, starting Sunday it is going to be dark at 5 p.m.  meaning that you are far more likely to get hit by a car at 5 p.m. next week than you are this week.   When I say “far more likely,” our estimate is that the risk is about three times as high!

Of course, you are also far less likely to get hit at 6 a.m. in the extremely unlikely event that you are out 6 a.m.  But, notice, but January 1 the sun won’t rise until after 7 a.m., and if DST was permanent, that would be 8 a.m.   Sunlight is the ultimate scarce resource.

Here is our previous coverage.

* The picture in the Costco piece is of me enjoying some daylight at Wrigley Field. Should Daylight Saving Time be eliminated? Of course not! More daylight means more daytime ball games.

Nobel Prize Agency

Oliver Williamson, Physicist?

This year’s Nobel Memorial Prize in Economic Sciences once again goes to some folks doing the heavy lifting on organizational theory.   You may recall that not too long ago, Elinor Ostrom and Oliver Williamson shared the award for their work on “governance mechanisms” — Ostrom on collective governance of natural resources, Williamson for organizational structure.

This year’s winners are Oliver Hart from Harvard and Bengt Holmström from MIT for their work on “contract theory”.    Contract theory is pretty encompassing, and includes the classic “principal-agent” problem, along with the “incomplete contracts” problem.

For the uninitiated, An agency problem arises when you as a principal delegate a task for some agent to carry out for you.  For example, you might own a business and hire someone (or someones) to work for you. That seems simple enough, except things can get all mucked up if output comes from a combination of effort and random factors, if you have several workers and can’t figure out who’s responsible for what (team production), if your workers have a bunch of things to do (multiple-task agency problem), and a host of other things.

Hart and Holmström have made fundamental contributions in getting to the heart of some of these matters, and were duly rewarded with the prize. Remarkably, Kevin Bryan from University of Toronto says that though Hart won the prize on the back of his contributions to “incomplete contracts,” he actually has not done much on incomplete contracts since two other Nobel winners — Eric Maskin and Jean Tirole, characterized the limitations of that approach:

Hart’s response, and this is both clear from his CV and from his recent papers and presentations, is to ditch incompleteness as the fundamental reason firms exist…. To my knowledge, Oliver Hart has written zero papers since Maskin-Tirole was published which attempt to explain any policy or empirical fact on the basis of residual control rights and their necessary incomplete contracts.

Professor Bryan has remarkably prescient characterizations of Hart and Holmström‘s work A Fine Theorem blog (incidentally, he often has excellent review and commentary on recent IO papers).   The post on Hart is essentially a short history of the economics of the firm and organizational economics, which many of you will be seeing next term in Econ 450.    There are a million other descriptions of their contributions (google it), including this critical piece by Arnold Kling.

And, congratulations to Milhouse!   Well done.

Quarterly Chartbook for the U.S. Economy

Interest rates and stock pricesInvestment analyst and former Lawrence professor Jeff Miller provides a weekly column entitled Weighing the Week Ahead  that employs many charts and offers an array of insights related to both the state of the U.S. economy and investment opportunities.  This week’s version provides a link to a quarterly chartbook assembled by JP Morgan that will give even the most numerate among us plenty of food for thought. One chart of particular interest to investors suggests that when 10 year U.S. Treasuries offer relatively low interest rates (e.g., below 5%), increases in their yield are correlated with increased stock returns.


Infrastructure Spending Is Not The Holy Grail

Politicians of all stripes (including Clinton, Sanders and Trump) seem to believe that more Federal spending on infrastructure is essential to increasing economic growth and creating attractive employment opportunities. In a recent lengthy article in City Journal, economist Edward Glaeser begs to differ. Glaeser, author of The Triumph of The City, recognizes that much of our infrastructure needs attention due to deferred maintenance, but that Federal money devoted to large scale infrastructure projects tends to be both inefficient and inequitable. Below are a summary of a few of his observations. I encourage you to read the entire article.

1. Many projects serve very few people; some have been described as “bridges to nowhere.”
2. Funding tends to follow political influence rather than economic need.
3. Most projects do not come close to passing any type of benefit-cost test.
4. Although projects in the late 1800s and the first half of the 20th century did lead to both increased productivity and employment, later 20th century projects and 21st century projects tend to generate neither increased productivity nor employment opportunities, especially for areas with high unemployment rates.
5. Consistent with point 2, many projects involve subsidies from poorer to richer parts of the country.
6. Both efficiency and equity would be improved if infrastructure projects, especially those related to transportation, were funded locally by users.

Economics 421 – Investments

Unfortunately, the catalog description for this course has not been undated to reflect the changes made last year (and this year.) Below you will the appropriate description.

ECON 421
This course blends a web-based course on investment philosophies with classroom discussion of economic and valuation principles. It aims for students to develop an understanding of contemporary financial markets and instruments as well as how economic fundamentals apply to the evaluation of investment alternatives and strategies. Students will apply such knowledge to craft their own economic philosophies and implementation strategies. Units: 6.
Prerequisite: I-E110 and at least one of ECON 300, ECON 320, and ECON 380.

The class is scheduled to meet Tuesdays from 9:50 to 10:50 and Thursdays from 9:00 to 10:50. I will NOT necessarily attend the Tuesday sessions; however, during reading period week, the class will meet from 9:00 to 10:50 (Tuesday, October 18th) as a replacement for the Thursday session.

If you have questions, please don’t hesitate to ask me or to come to the first session next Tuesday at 9:50.

Obamacare: Repeal and Replace vs. Reform

Republicans and Democrats are strongly divided over what should happen to the ACA. Most Republicans have identified the repeal of the Act as a high priority. Most Democrats seek to reform the Act by addressing gaps and errors in the legislation. Such a characterization of these battle lines is much too simplistic. In some cases, the proponents share the same goals but offer different strategies and policies to achieve them; in others, the proponents disagree about both goals and policies. This blog posting seeks to illuminate a few of these distinctions; more complete discussion can be found here.

Truth And Consequences 512

Goal #1 – Ensure access to health insurance for all Americans

Comment: Largely a shared goal
Republicans: Available tax credit to be used voluntarily with few restrictions.
Democrats: Expand participation in the ACA and provide more incentives to induce those not insured to become so.

Goal #2 – Reduce incentives to purchase expensive health insurance plans
Comment: Shared goal
Democrats: 40% excise tax on premiums above a prescribed level
Republicans: Premium above a prescribed level are subject to the income tax on an individual basis.

Goal #3 – Regulation of health insurance markets
Comment: Not a shared goal
Republicans: Deregulate to a large degree with few restrictions on insurers to induce more competition and range of health plan options.
Democrats: Strong pre-existing conditions clause prohibitions and state-based purchase and regulation.

Goal #4 – Choice of health plan
Comment: Largely a shared goal
Democrats: Encourage competition through the market place exchanges with provisions to counteract adverse selection; that is, risk corridors, re-insurance pools, and risk-adjustment used to assist private insurers who attract relatively high cost enrollees.
Republicans: Allow consumers to purchase in-state or out-of-state health plans they see as best meeting their preferences.

Goal #5 – Provide Medicaid for Low Income Residents
Comment: Largely a shared goal
Republicans: Federal block grants to the states with states having a great deal of flexibility in determining composition of plans as well as eligibility.
Democrats: Federal government largely determines both eligibility and a large portion of the benefits covered.

Since the ACA law covers well over 900 pages, many provisions are not addressed here. This posting seeks to illuminate where Democrats and Republicans might find common ground and where they are unlikely to do so. Furthermore, given the instability in the exchanges in many states, reform of the 3 Rs – reinsurance, risk corridors, and risk adjustment – will be a priority if the exchanges are to be stabilized and survive.

Fama & Thaler on the EMH

The Chicago Booth School gives us a spectacular interview with Eugene Fama and Robert Thaler on the efficient market hypothesis, the idea that prices reflect all available information.   

Thaler says he likes to parse this statement in two parts:  The first is whether you can individual investors outperform the market (doesn’t look promising); the second is whether prices are “correct” at any given point in time (I suppose it depends on what you mean).

The discussion is absolutely great, and you will learn a lot about economic modeling and thinking about testing economic models from two leading scholars who have thought a lot about it.   At one point, Fama somewhat hilariously (to economists, at least) declares himself to be “the most important behavioral-finance person, because without me and the efficient-markets model, there is no behavioral finance.”

Incidentally, the Booth school is also the source of the Initiative on Global Markets polls of economists, leading to the remarkable Which Economist are You Most Similar To? interactive tool.



Monetary Policy in an Age of Radical Uncertainty

Central bankers in all major developed economies have adopted NIRP, ZIRP, or near ZIRP policies.  The Bank of Japan and the European Central Bank now “offer” negative interest rates (NIRP) on reserves and project to do so for the foreseeable future.  The Bank of England and the Federal Reserve Bank of the United States remain committed to targeting interest rates slighted above zero (near ZIRP).  10 year government bonds offered by these countries range from -0.225% in Japan to -0.027% in Germany to 1.57% in the U.S. Such policies are not consistent with sustainable economic growth. See Professor Gerard’s previous posting on the pervasiveness of such interest rates.

In a recent book entitled The End of Alchemy, former Bank of England Governor Lord Mervyn King argues that the policies we have employed in the past (and present) to stabilize our economies – such as keeping interest rates low until economic growth returns to its long term rate or unemployment falls below some designated benchmark (full employment? natural rate of unemployment?) – are inconsistent with sustainable economic growth.  Furthermore, he suggests that central bank and regulatory policies adopted post Great Recession (December 2007 – June 2009 in the U.S.) fail to address the potential for a repeat of the financial failures witnessed during that period. Among other points, King observes the following (for more in depth comments on King’s insights go here.)

  1. In the contemporary world economy, many shocks to the economy are unpredictable; thus, one cannot use probability-based forecasting models to design policy to stabilize economies.  (King calls this radical uncertainty)
  2. Policies designed to stabilize economies in the short run, such as aggressive monetary and fiscal policies, leave a residue inconsistent with long run economic growth unless stagnation is viewed as the desired norm. For King, policymakers face the stark trade-off of short term stability for long term sustainable economic growth.  In contrast to Keynes, in the long run, we are NOT all dead.
  3. In contrast with central banks as “lenders of last resort,” King offers the innovative idea of “pawnbroker for all seasons” as a constructive substitute.  Banks would know in advance what their liquid assets will bring them in terms of central bank conversion to cash.

Each of the above points demonstrates how King views central banking and bank regulation in a world characterized by radical uncertainty.  In short, policy makers need to find viable coping strategies to reduce the downside cost of economic recessions in general and financial meltdowns in particular. With radical uncertainty, the “forward guidance” offered by central banks lacks credibility and fails to address such uncertainty.   In the words of Michael Lewis ( of Liar’s Poker, Moneyball and the Blind Side fame), “if his book gets the attention it deserves, it might just save the world.” (

Gladwell Claims There is No Free Lunch

In his latest Revisionist History podcast, Malcolm Gladwell gives us some food for thought about where we put our resources.  He claims that small liberal arts that develop gourmet-level dining services are doing so at the expense of bringing in  low-income students.  To develop his argument, he compares two elite schools from the northeast, characterizing the situation thusly:

They compete for the same students. Both have long traditions of academic excellence. But one of those schools is trying hard to close the gap between rich and poor in American society—and paying a high price for its effort. The other is making that problem worse—and reaping rewards as a result.

His logic is pretty straight forward: Schools have a budget constraint, and at the margin they can spend an additional dollar on financial aid or on campus amenities.  A school that invests in campus amenities will draw more students willing to pay a premium price, whereas a school that skimps (relatively speaking) on amenities in favor of financial aid will be at a relative disadvantage in two ways:  First, students generally prefer high-quality amenities to low-quality amenities. Second, it generates less revenue per student and therefore fewer resources to put into financial aid or campus amenities.

Malcolm Gladwell is an influential writer with best sellers to his credit such as Outliers and The Tipping Point, as well as about a million New Yorker articles, so this pieces is certain to make waves.  That he calls the investment in high-end dining services “a moral problem” and implores students not to go to schools with ridiculously good food pretty much ensures people will be up in arms about this.

This is also relevant from our perch here at a small liberal arts school with our own financial decisions to make.  I was more amused than convinced by the thesis when I first read the abstract, but after looking at the numbers and listening to Gladwell, I am more sympathetic (scroll down the Revisionist History page for the photo of a banana chocolate chip waffles with the school logo emblazoned in the center).   Though, I guess that’s why Gladwell is such a popular figure:  he makes an interesting claim, tells a good story, and makes a good case.

As an aside,  I think I speak for most people who attended a residential campus prior to 2000 when I say that the food even at campuses that “skimp” on quality is ridiculously good compared to what we ate (though I did love the Monte Cristo sandwich on Thursdays).

You can read more about it at the always lively Inside Higher Ed website.

Addendum:   It’s probably worth adding that it’s still okay to complain about food at your school.   You probably pay a lot of money for dining services, and with that, you expect certain levels of quality, variety, and availability.

A quick peek reveals that the average U.S. household (a.k.a., consumer unit) spends about $6,800 annually on food compared with college meal plans that run $2000-$3500 per semester.