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Economics and Business What’s the Difference? Business: Make Decisions that Optimize Firm’s Objectives given Scarce Human and Financial Resources Is Information about National, State or Local Economy’s Performance Useful for Business Decision-making? Economics: Explains how Goods and Services are Produced, Distributed and Consumed What’s “different” about the Current Recession? Haven’t we seen this movie before? “Growth alone will not resolve an increasingly complicated debt equation. Preserving debt affordability – the ratio of interest payments to government revenue – at levels consistent with AAA ratings will invariably require fiscal adjustments [Tax Increases or Spending Reductions] of a magnitude that, in some cases, will test social cohesion.” March 15, 2010. Moody’s Elastic/inelastic demand Elastic Demand: Quantity Demanded is Highly Responsive to Price Changes (Flatter Curve) Inelastic Demand: Quantity Demanded not as Responsive to Price Changes (Steeper Curve) Does this Explain why “Sin Taxes” Pay for Education and Health Care? Macroeconomic issues Four Measures to Follow Gross Domestic Product (GDP): National, Regional and Local Unemployment/Employment Rate: Job Growth, Wage Levels and Labor Supply Inflation: Consumer Price Indexes Interest Rates: Leading Indicator that is Principal Tool of Monetary Policy Notes and Comments GROSS DOMESTIC PRODUCT Does Not Include International Output Difficulty of Measurement raises Reliability Concerns Coarse-grained Measure: National Income Trends may not reflect State or Local Conditions UNEMPLOYMENT RATE What is Causing Changes in Unemployment Rate: Job Growth (Numerator) or Labor Force (Denominator)? Could High Unemployment Rate be Politically Undesirable but Favor Economic Development? QUESTION: What was Oregon’s Unemployment Rate when Intel announced it would build its first plant? 1982: 11.5% Current: 10.5% National: 9.7% Notes and Comments INFLATION RATE What are the Products or Services in the “Basket”? What’s the Geographic Area covered by the Survey? Many Types and Forms of Consumer Price Indices Theory and applications INTEREST RATES Interest Rate is “Rent” for Using “Other People’s Money” Debt Service: Repayment of Principal and Interest on Date Certain Leading Economic Indicator: (1) Future Economic Conditions (2) Capital and Operating Costs Theory and applications INTEREST RATES Reflect Risk of Waiting to be Repaid Business Risk: Likelihood Borrower will Repay in Full and on Time “Bird in Hand”: Effects of Inflation during Loan Term Opportunity Cost: What happens if “Better Deal” comes along? Yield curve: Market dynamics Upward-sloping Yield Curve reflects “Time Value of Money” Yield Curve on April 1 Source: www,stockcharts.com/charts Analogous to Supply Curve: Lenders willing to Supply Credit for Longer Terms if Compensated with Higher Price (Interest Rate) for bearing Firm-specific and Systematic Risks Theory and applications Compare Rates* in 1971 with Current Rates: Why wouldn’t you borrow as much as you can? *FHLMC 30-Yr. Fixed Rate SFR Theory and applications REGULATING THE NATIONAL ECONOMY Why do it? Promote Employment and Price Stability _______________________________________________ How to do it and Who should do it? Fiscal Policy - Government Actions (Taxes/Spending): “Direct” Effect Monetary Policy – Federal Reserve System (Interest Rates/Money Supply): “Indirect” Effect The Case of Hurd v. Rock Island Railroad “This current of travel [east and west] has its rights as well as those of north and south.” May 6, 1856 A National economy Promontory Summit, Utah May 10, 1869 FISCAL POLICY ISSUES MULTIPLIERS Benefit/Cost Ratios Government Spending Personal and Business Tax Decreases Obama Assumptions $1.57 to 1 $0.99 to 1 Economic Studies and Models $1.40 to 1 $3.00 to 1* Why did Policy Choice favor Government Spending? * Romer and Romer (2009) American Economic Review Theory and applications Federal Reserve System’s Duties Conduct Nation’s Monetary Policy Pursue Maximum Employment and Stable Prices Supervise and Regulate Banks Ensure Safety and Soundness of Financial System Theory and applications Federal Reserve System Structure Twelve Member Banks Board of Governors: 7 members appointed by President and Confirmed by Senate for staggered, 14-year Terms Current Chair: Ben Bernanke Federal Open Market Committee Theory and applications Conducting Monetary Policy Monitor Availability of Credit by “Influencing Federal Funds Rate” Regulate Money Supply with Bank Reserve Requirements Federal Reserve’s Independence Theory and applications Conducting Monetary Policy The Fed’s Three Tools Discount Rate: “Lender of Last Resort” Regulate Money Supply with Bank Reserve Requirements Open Market Operations: Regulate Credit Availability by setting Target for and “Influencing” Federal Funds Rate Theory and applications Conducting Monetary Policy: Reserve Requirements LIABILITY TYPE RESERVE REQUIREMENT (Percentage of Liability) Net Transaction Accounts $0 to $9.3 Million 0% More than $9.3M to $43.9M 3% More than $43.9 Million 10% Non-personal Time Deposits 0% Eurocurrency Liabilities 0% Net Transaction Accounts: Demand Deposits and Other Transactions maturing in Seven (7) days or less What is the “Federal Funds Rate” and does “Influencing” it Influence other Interest Rates? “Federal Funds” are Loans of Excess Reserve Balances that Member Banks make to one another By trading Government Securities, “The Fed” influences the Federal Funds Rate, which is the Interest Rate that Member Banks charge one another for Overnight Loans of Excess Reserve Balances What is the “Federal Funds Rate” and does “Influencing” it Influence otherFed Interest Rates? Rate” raises “Target to Slow-down Economy 30-Year Mortgage Rate Balances maintained Doesn’t Change “Federal Funds” are the Reserve by Banks with the FederalThis Reserve is NOT how Things By trading Government Securities, “The Fed” Fed lowers “Target influences the Federal Rate” to Stimulate Economy 30-Year Funds Rate – -the Interest Mortgage RateBanks also Rate Member charge Decreases one another for This IS how Things are Overnight Loans of Excess Supposed to work Reserve Balances are Supposed to work Open Market Operations Trading Range of Federal Funds Rate compared to Target Rate (0% to 0.25%) If Federal Funds Rate trades above Target Rate Range, Open Market Operations buy Securities and Increase Supply of Reserves. If Demand is unchanged, Federal Funds Rate should decrease to be within Target Range Open Market Operations: How they work GOAL: Lower Interest Rates to Stimulate Credit Demand and Economic Activity ACTION: Federal Reserve Buys Government Securities EFFECT: Dealer/Sellers deposit Cash received from Federal Reserve in Bank. Deposits increase Bank’s Supply of both Loanable Funds and Reserves PA QA Increased supply of Federal Funds (QA>QE) decreases Federal Funds Rate and other Interest Rates (PA<PE) Monetary Policy Action Increased Supply of Credit and Lowered Price of Credit Yield curve: Market dynamics Was a “FLAT” YIELD CURVE to blame? • Should Long-Term Risk (30 years) and Short-Term Risk (3 months) be Equally Compensated? • Wasn’t that what Financial Markets were trying to do? • What happens When (Not If) Inflation comes back? Source: www,stockcharts.com/charts Theory and applications What about the Safety and Soundness Duty? What explains the “Sub-prime Mortgage Mess?” What happens when Bankers lose Depositor’s Funds by making Bad Loans? Does Deposit Insurance encourage Risky Behavior (Moral Hazard)? DECISION-MAKING PERSPECTIVES PURPOSE Strategic or Tactical? SCALE SCALE Large versus Large or Small? Small APPROACH Entrepreneurial or Managerial? PURPOSE Strategy: Deciding What to Do (Make Policy) Tactics: Deciding How to Do what has been decided to be done (Take Action) SCALE Small Firms: 500 or fewer Employees and Privately Held (Stock not traded in Publicly-accessible Market) Large Firms: More than $10 Million in Assets and more than 500 Stockholders APPROACHES Managerial versus Entrepreneurial APPROACHES Entrepreneurial versus Managerial Competitive Advantage Entrepreneur Manager Obtain Protect Income Context Long-term Resolve Uncertainty Short-term Minimize Risk