Archive for the 'Expectations' Category

Apr 07 2008

Doom and gloom in the headlines as US economy teters on edge of recession…

Judging by today’s headlines, things aren’t looking too hot for the US economy:

From the last article:

In his bleakest economic assessment to date, the Federal Reserve chairman, Ben S. Bernanke, said Wednesday that the American economy could contract in the first half of 2008, meeting the technical definition of a recession, and he encouraged Congress to help homeowners caught up in the mortgage crisis.

For the first time during his three years in the job, Bernanke has admitted we could be in a recession, defined as two consecutive quarters of negative GDP growth. By June, we could very well have experienced just such a decline in output; every central banker’s nightmare!

The source of America’s economic woes? Weak housing market. In fact, house prices have fallen around 10% nationwide over the last 12 months. To understand why, we need to recall the basic microeconomic principles of supply and demand. Quite simply, too many homes were built over the last decade, as low interest rates and optimism about the continued strenght of the housing market (rooted, of course, in the irrational exuberance about the economy as a whole) led builders to expand the suburban sprawl like never before, anticipating growing demand forever into the future. Problem was, demand couldn’t keep up with supply, and now the price is starting to reflect this basic economic principle.

To make things more complicated, many home buyers over the last seven years should never have been given loans based on their credit histories and household incomes. Many of these buyers were thus given “sup-prime” loans, many with adjustable interest rates, which means that today people who were too poor to get a normal loan four years ago are seeing their monthly payments increase just as the economy is slowing down. Rising unemployment puts downward pressure on wages, and inflation (caused by rising energy and commodity prices) forces poor homeowners to allocate more of their wages towards food and electricity, making it doubly hard to make their monthly mortgage payments.

The outcome is predictable: foreclosures. Banks that made loans to uncreditworthy buyers are now taking the houses back and putting them on the market for really low prices, putting even more downward pressure on all home prices. Since their homes make up the majority of Americans’ wealth, and since wealth and disposable income are the main determinants of consumption, inflation and falling home prices both lead to huge decreases in consumption.

The cycle continues: declines in household consupmtion signals to firms that it’s a bad time to invest, so investment spending declines. As consumption and investment fall, aggregate demand shifts in, causing output and employment to fall, hence our current recession.

“It now appears likely that real gross domestic product, or G.D.P., will not grow much, if at all, over the first half of 2008 and could even contract slightly,” he said. “We expect economic activity to strengthen in the second half of the year, in part as the result of stimulative monetary and fiscal policies.”

For now, however, judging by today’s headlines, conditions will continue to worsen for the American worker, homeowner, consumer and firm.

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Jun 01 2007

Can you say, “paranoia”?

Promotional Fax Mistaken for Bomb Threat –

the threatening fax!

I don’t know, but I would say the American people are a little on edge these days. What does it say about our society when a paranoid bank employee receives a fax and calls in the bomb squad? The arrival of the threatening fax coincided with the arrival of a “suspicious” package, escalating the fears of the terrified bank staff. Turns out the fax was from the corporate office, and the package contained some paper files, but by the time police figured it out 15 local businesses and a nearby day care’s 30 children had been evacuated from the area!

Okay, so this story may not appear to have much to do with our Econ course… or does it?

Discussion questions*:

  1. What impact might mass paranoia about terrorism have on the macro economy? Explain.
  2. Would the free market provide the security and protection needed to ensure a healthy and safe environment for investment? Why or why not?
  3. What is the term for a service or product that provides spillover benefits for society but which is under-provided by the free market (such as a police force)?
  4. Do you think the bank employees were right to be frightened by the threatening fax? Is their fear rational or irrational given the political and social climate in America today?

*From now on, most of the posts on this blog will include discussion questions. These are meant to help students start their own discussion about the issues raised in the posts and how they connect to our economics course. Posts like this one are tagged with a category, and next year when we get to a particular topic in our Econ course, students will be asked to find a past post from that category on the blog, read it and post their comments. This will become a part of students’ grades. To see how the blog will graded, click here.

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