Deflation Threat Recedes: "It" Didn't Happen Here

December 2009 inflation data showed the U.S. Consumer Price Index rising at an annual rate of 2.7 percent over the preceding 12 months. After several months of negative numbers earlier in the year, it appears that the threat of deflation has receded.

Just a few months ago, some economists were more pessimistic. When the economy enters a severe recession, conventional monetary policy can lose effectiveness. As interest rates fall to near-zero, banks tend to accumulate excess reserves. At the same time, velocity may slow down. As a result, the link between monetary policy instruments and GDP weakens, and the central bank finds itself "pushing on a string."

In 2002, Ben Bernanke, then a newly-appointed Fed governor, dealt with these issues in a speech entitled "Deflation: Making Sure 'It' Doesn't Happen Here." In the speech, he proposed that if a threat of deflation ever did loom, the Fed could maintain effectiveness of monetary policy by taking unconventional actions, including buying longer-term securities and extending loans to financial institutions outside the commercial banking system. He was confident that if the Fed was bold enough to use all the tools at its disposal, "It"--Japanese-style sustained deflation--could not happen in the United States.

Now that the Fed appears to have saved us from the threat of deflation, it must turn its attention to finding an "exit strategy" for reabsorbing the massive quantity of liquidity it has injected into the financial system. Already, the Fed has begun to unwind some of its positions, but bank reserves are still extraordinarily high. More work remains to be done to make sure the economy does not come out of recession straight into inflation.

Click here to download a free set of PowerPoint slides that show the lastest inflation data and highlights of monetary policy over the last two years. If you find them useful in your economics course, please post a comment or send me an e-mail. I'd like to know how you use this material, and what you'd like to see next.

Are Pay-for-Delay Drug Deals Anticompetitive?

In January, the Federal Trade Commission published a new study claiming that so-called pay-for-delay drug deals are costing consumers $3.5 billion per year.

Pay-for-delay drug deals are, in large part, an unintended consequence of the Hatch-Waxman Act of 1984, which was intended to allow earlier market entry for generic drugs. Under certain conditions, Hatch-Waxman allows generic drug makers to begin selling their products before the patent on the brand-name drug expires. However, producers of generics who attempt to use this early-entry mechanism are sometimes sued by the brand-name producer. Often, the suits never come to trial. Instead, a pay-for-delay deal is reached in which the maker of the brand-name drug pays a large sum to the generic manufacturer, in return for which the latter agrees to stay out of the market. The FTC calculates that the average delay achieved by such deals is 17 months.

Pay-for-delay deals are profitable for both companies if the payment is smaller than the profit that would potentially be lost by the brand-name manufacturer, but greater than the potential profit earned by the generic producer. Both elementary economic theory and empirical evidence suggest that this condition will often be satisfied. It is equally clear that consumers are the losers when such deals are reached.

The legal status of pay-for-delay deals is murky. In the early years after passage of Hatch-Waxman, they were considered anticompetitive per se, and very few such deals were made. Then, beginning in 2005, federal appeals courts determined that the deals were legal, after all. The number of such deals increased rapidly.

Now there is a push to end pay-for-delay deals once and for all. They are under attack both by the Federal Trade Commission and the Antitrust Division of the Justice Department. In addition, the House version of the omnibus health care bill currently under consideration by Congress would outlaw pay-for-delay. The Senate version does not include this language. (The final fate of the legislation is not yet known as this is written.)

To download a free set of PowerPoint slides that explain the pay-for-delay controversy, follow this link. The slides include a simple graphical model that can be used as a classroom example in your principles of microeconomics course. If you find the slides useful, please post a comment, or send me an e-mail.

2009: A Bad Year for Jobs, but Some Light at the End of the Tunnel

2009 Was a bad year for the U.S. job market. Unemployment hit a peak rate of 10.1 percent in October, and barely edged down to 10.0 percent in November and December. There was a glimmer of hope when 4,000 payroll jobs were added in November, but payroll employment declined again in December, by 85,000 jobs.

Some observers were heartened by the fact that unemployment did not rise to its previous post-World War II peak of 10.8 percent, recorded in December 1982. A more significant ray of light at the end of the tunnel was the fact that the rate of job loss slowed dramatically toward the end of the year, compared with monthly losses in the hundreds of thousands in earlier quaters.

Looking beneath the headline unemployment and payroll numbers, it was harder to find good news. The structure of unemployment by duration worsened significantly. By year's end, nearly 40 percent of the unemployed had been out of work six months or more. Long spells of unemployment are considered especially damaging since they may lead to a loss of job skills.

Broader measures of labor market hardship also worsened. Some observers consider the measure "U-6" to be the best measure of labor market hardship. In addition to workers included in the standard measure (which includes only those who are not working, but actively looking for work), U-6 adds others who suffer from bad labor market conditions. These include discouraged workers and other marginally attached workers, who say they would look for work if they thought any work was available, and also people with part time jobs who say they would prefer to work full time. U-6 rose from 13.5 percent  of the labor force in December 2008 to 17.3 percent in December 2009. Furthermore, U-6 edged slightly higher in November and December, even after the standard measure of unemployment flattened out.

To download a free set of PowerPoint slides summarizing the 2009 employment situation, follow this link. Feel free to cut-and-paste the slides into your lectures, or assign them to your students as independent reading. If you like the slides, please post a comment or send me an e-mail.

Will High Pork Prices Ruin the Holidays?

The supply and demand model is the core of microeconomics. You can never have too many examples in your classroom. Here is a simple example that will help students distinguish between shifts in demand and shifts in supply. As a bonus, the case also illustrates import restrictions, if you want to use it in conjunction with your international trade lectures. The attached PowerPoint slides can either be used as part of a classroom discussion, or printed out (with the answers deleted), and used as a quick quiz.

Pork is a popular dish in Malaysia among those who celebrate the Chinese New Year holidays. (About a quarter of Malaysia’s 28 million people are of Chinese descent.) This year, though, consumers are grumbling at high pork prices, which have reached 7.65 Malaysian ringgits per kilo at the wholesale level (about $1 per pound) . They are blaming anyone they can think of—pork producers, the government, whoever.

What is behind the high prices? Beh Kim Hee, chief of the pork section of the Federation of Livestock Farmers Associations of Malaysia, says it's normal supply and demand. Demand is up because of the holidays. At the same time, the need to upgrade production facilities to meet sanitary standards is raising the cost of production.

Those who blame the government seem to be on to something, as well. The government bans the import of fresh pork from neighboring countries like Vietnam, China, and Thailand, where it is a third or more cheaper. National Pork Sellers Association president Goh Chui Lai has urged the government to end the ban. Not surprisingly, Mr. Beh, the pig farmers’ representative, objects to removal of the ban.

To download your free PowerPoint slides for this item, click here. Source: Based on information from Meat Trade News Daily, December 31, 2009, supplemented by other sources. To view the original news item, follow this link.

Carbon Prices Fall on Copenhagen Results

The principle of revealed preference, a cornerstone of economic thinking, tells us that if you want to know what something is worth, look at how much people are actually willing to pay for it. The cap-and-trade approach illustrates revealed preference in action. It is based on the idea that a tight cap on emissions will induce polluters to pay a relatively high price for carbon permits, thus giving them a substantial incentive to clean up. A more lenient cap, or uncertainty as to how tight the cap will be, will lead to low permit prices and weak incentives to control pollution.

Following this reasoning, the price of carbon permits under the European Union's cap-and-trade system for greenhouse gasses should provide a better measure of the success or failure of the recent Copenhagen conference on climate change (COP-15) than any number of newspaper editorials or political press conferences. Permit prices peaked at about 15 euros per ton as the conference started on December 7, reflecting optimism that the 193 participating countries would reach a relatively strong agreement to follow up on the expiring Kyoto Protocol. However, when the conference ended on December 20 with only the broadest agreement on general principles, permit prices dropped to under 13 euros per ton.

Commenting on the outcome of the conference, business executives most of all deplored the lack of certainty about the future direction of climate change policy. Until they have some indication of how serious governments are about climate change policy, they are likely to delay the huge investments that will be necessary to slow greenhouse gas emissions anywhere close to the targets environmentalists see as necessary.

To download a free set of PowerPoint slides summarizing the results of the Copenhagen conference and their effect on carbon prices, click on this link. If you find the slides useful, please post a comment or send me an e-mail.

How Healthy are US Banks?

December has seen a spate of good news about US banks. Many banks report a return to profitability, with record earnings in some cases. The largest banks have repaid, or are in the process of repaying, the money that they borrowed from the government's Troubled Asset Relief Program (TARP). The Treasury even claims to have earned a profit on TARP funds repaid so far. Does all this mean that the banking system has returned to health?

Not so fast. There is some bad news, too. On balance, it appears that the US banking system has a long way to go to be fully healthy. Here are some of the negatives:

• Bank lending activity has not increased since the inception of TARP in October, 2008. In fact, by some measures lending has declined.
• Bank profits are coming from trading activities, not from lending. This limits the positive spillover from Wall Street to Main Street.
• Banks point out that one reason they are not lending more is that lending remains risky in a weak economy. This argument seems justified at least in part. For example, the percentage of nonperforming loans continues to rise, especially at the largest banks.
• The Federal Deposit Insurance Corporation (FDIC) reports that the number and size of problem banks continues to increase. "Problem banks" are those that have received low marks on regulatory reviews, even though they remain solvent for the time being.

Even the Treasury's claim to have profited from TARP repayments is subject to question. As part of a deal on terms of repayment, some banks have received lenient rulings on carry-forward of past losses. These rulings will cost the Treasury billions of dollars in future tax revenues, offsetting any TARP profits from interest payments and sale of warrants. Furthermore, although the largest banks have repaid their TARP funds, many smaller banks have not, and some may never succeed in doing so.

Some critics believe that banks should not have been allowed to repay TARP funds so soon. They say that the primary motive for early repayments is the desire to escape government limits on bonuses for top executives and traders. Early repayment may come at the expense of shareholder value, and failure to rebuild capital could lead to the need for more bailouts in the future.

To download a free set of PowerPoint slides summarizing these points, click on this link. If you find the slides useful for your course, please post a comment!

Microsoft Settles EU Antitrust Case

On December 16, the European Union announced a settlement in its long-running antitrust case against Microsoft. The settlement responded to a complaint that Microsoft's practice of bundling its Internet Explorer web browser with the Windows operating system constituted unfair competition.

In contrast to the 2007 settlement of an EU complaint regarding media players, which cost Microsoft more than $2 billion dollars, this time no money will change hands. Microsoft agrees to provide European users with a pop-up "ballot" that will allow users to "vote" on their choice of web browser. (Microsoft points out that users already had such a choice.)

To download a free set of PowerPoint slides describing the settlement and reviewing the history of Microsoft's antitrust troubles in the US and the EU, follow this link.