Ask an Economist

Question:
I do not fully understand how Open Market Operations of US Treasury Bonds by the Fed increases the money supply, i.e. reserves. Treasury issues a $1000 bond which is given to a primary dealer to auction off. The NY Fed buys that particular bond by crediting the dealer's bank account with $1,000 the Fed just created. But doesn't the dealer now have to remit that $1,000 to Treasury? The dealer is at net $0.00 (ignoring commissions or other minor amounts). So when the Fed buys bonds, the new money actually ends up at Treasury. That doesn't seem to agree at all with my reading that the new money is held as reserves at commercial banks. Can you please clarify?
Answer:

Money supply increases when the FED (say NY FED) buys T-bonds from other banks (say Wells Fargo) or non-bank public (say a household or a dealer) in a secondary market, NOT a primary market. The Treasury does not get anything if its assets are...

Question:
What is your opinion on the potential impact of the proposed Nicaragua Canal, a trade route that would connect the Pacific Ocean to the Caribbean via Lake Nicaragua, on the Nicaragua economy?
Answer:

I will focus on the benefits of the Canal when it becomes operational, because a project of this magnitude is very likely to create numerous temporary jobs and plenty of opportunities for local companies in the construction sector during the...

Question:
I would like to get your educated opinion on Right to Work, specifically, what will happen if all 50 states in our country become RTW states.

Right now, it is attractive for a corporation to set up or move their business to a RTW state due to lower wages and not having to deal with strong unions. I understand this. But how will a RTW state entice a company to move FROM a RTW state?

Cut corporate taxes? Suppress wages? Reduce services to the tax payers so more money can be given to the corporation? How will states entice business to set up shop once this is a Right to Work country? Thanks for your time.
Answer:

Your question requires that I explain some of the background for Right-to-Work laws, and I took the liberty of adding a more general answer on the effect of Right-to-Work on the economic outcomes for firms and workers.

Union strength in...

Question:
I would like to ask you a basic question of not understanding quantitative easing. I understand the mechanics but I don't understand why this is considered pumping in "fresh" money, since the FED is just buying up Bonds that were purchased before. They are NOT just giving away absolutely free to BANKS. I know it's wordy but the below elaboration details my confusion. Hope you can help. Thank you!

In quantitative easing, the process of US Fed Bank buying bonds from Banks in order to increase money supply is pretty straight forward but no one seems to be able to explain my particular question or I guess confusion. I even posted on the US Fed open market website but they just gave me the typical answer I already knew.

Again, I'm aware that the FED can pretty much "print money" out of thin air and "inject" it into system but when I look closer at the details of what is happening, I still have trouble describing the process of injecting "fresh" money into an economic system because it looks as though they are limited by putting back the money that was spent to buy the bonds in the first place by banks.

So, to elaborate what I'm trying to say is that if you have a situation of the FED just giving away cash or call it a credit on their ledger for various banks out of the blue. Now that is exactly what I would call injecting fresh money because the banks didn't have to do anything or exchange anything in order to receive that money, just like if I were walking down the street and a complete stranger just came up to me and handed me cash. Now that scenario is what I would understand as injecting fresh money on top of a system.

But what is really happening is that under open market operation for quantitative easing, the US FED is buying up all the bonds that banks are holding at a given moment. Those bonds were purchased at an earlier time by various banks by giving money to the FED or other government agencies, so it looks at best to be putting all the money back into a system in which those monies were extracted from the system before, therefore it's not a "fresh" injection of new money. So it's just putting equal money back into system that was taken out at earlier time? Isn't it?

In other words, let's just say for simplicity that all US Banks spent $1 Trillion to buy bonds 5 years ago (so 5 years ago, $1 Trillion was taken out of an economic system) And now, 5 years later the FED is buying up those bonds from the banks(putting $1 Trillion back into system) The net effect is no new fresh money.

Put it another way, if you add up all the bonds that banks are holding, let's say it comes to $1 Trillion, the FED even though they want to inject $2 Trillion into system over time, they can not do that because all the bonds that are out there doesn't equal $2Trillion; they can only purchase back up to $1Trillion. So the saying, the FED can "print" money as much as they want into a system is not possible, at least in this example of how they do it now in the real world.

I'm sorry for such wordiness but you won't believe how much misdirected answers I get even from professionals. I'm really hoping you can shed some light on my confusion.
Answer:

Let me try to answer your question by breaking it down.

“In other words, let's just say for simplicity that all US Banks spent $1 Trillion to buy bonds 5 years ago (so 5 years ago, $1 Trillion was taken out of an economic system)”.

...

Question:
Why is it that the largest market fluctuations, by a large majority, mainly happen in September, October and November? What about those three months causes the massive fluctuations? It happened in 1929, 1987 and 2008.
Answer:

At present, I am not aware of a widely accepted academic research in economics and finance that would provide a definitive explanation for the exact calendar timing of major financial market fluctuations in the United States for the time period...

Question:
With all the killing of poultry by bird flu and euthanizing that will this do to the retail poultry prices?
Answer:

Avian influenza has continued to spread, particularly in flocks of egg-laying hens. When a farm encounters a case of avian influenza, some birds die and others are euthanized. In the immediate short-run, this translates into a direct reduction in...

Question:
Hello. First of all, this idea about answering economic questions is just wonderful and very helpful to simple citizens, but to people like me, too, who are studying economics and want to ask some things. My question has to do with the rate between two currencies. I know the basics but I would like a deeper answer on what it means for the countries the two currencies represent. For example, how can we understand which country is more powerful when we know the rate between their currencies. A few examples, such as with the euro and dollar, would be appreciated in order to understand it better. Thank you in advance!!
Answer:

The rates don’t reflect relative power. For example, 1 UK pound equals about 1.56 USD. That does not at all mean that UK is more powerful. Similarly, a US dollar approximately exchange for 122 Japanese yen currently. By no imagination, it means...

Question:
Hi.. I am a writer. I am from India.. I need some help on a story I am writing based on economics.. India is a poor as well as a wealthy country. Therefore, it seems to me that money has a dual purpose - Basic Survival and Human Ambition. The poor I see are busting their asses off just to reach basic survival, while the rich are making millions by the strength of their ambition, intelligence, and passion.. I have always heard the argument that printing money to get rid of poverty will in turn lead to inflation thus in turn leading to even bigger poverty. But one day, I had a different idea... What if, anyone is allowed access to print money.. Every money that is printed can only be accepted by government bodies providing basic necessities like food, basic clothing, water, and modest shelter. These government bodies can later exchange that money for anything they want. But the initial printer cannot exchange the first printed money for anything but only for basic public services. All the money in the market will therefore come from a government source providing one of basic services to people. If people want to then improve, meaning if they want to go to a fancy restaurant rather than a public mess,, they will have to earn that money.. Therefore earning money will be associated with human ambition and passion while money itself will be associated with public basic needs.. With survival out of question,, all people can focus on doing a personal business, taking better jobs, etc. in order to improve their lifestyle; economy will bloom... What I need to know, is, for the sake for my story,, what things can go wrong in this model?? Why is this kind of a system practically impossible because I assume if it was possible it would have been already there.. What are the flaws of this model?? Why does this sound too good to be practical?? I thank you for your time and your patience.. I hope to hear from you soon..
Answer:

I think you don't want everyone to have access to the money-printing press or if you do, then let there be a fixed limit (say, they can print no more than a thousand "basics", the name of this currency). If anyone can print as much basics as they...

Question:
What's the best place to put your money if your primary focus is preserving its value? During the recent financial crisis, stocks and bonds went down the tubes. Government debt is approaching unsustainable levels, the Fed is "printing money" (via quantitative easing) like it's going out of style, and it's all fiat money anyway, so keeping cash is looking riskier all the time. Real estate (housing) also lost value during the crisis, is highly illiquid, and has ongoing costs (property taxes). Is gold the answer? Is any place safe in a crisis? Help!
Answer:

First, a disclaimer. Whatever is written below is not actual investment advice; it is general economics discussion, a dinner table conversation, no more. When it comes to preserving value, it becomes important to figure out, over what length of...

Question:
How does the government's disposal/burning of elephant ivory protect the market from illegal trading/poaching?
Answer:

If the government destroys ivory this year, then there is less of it this year which may cause price of ivory to rise. That may dissuade some current potential buyers. (I am assuming the government is destroying ivory that would otherwise be...

Question:
Hello economists! Regarding people who are unemployed --if every one of them went through the motions and started their own small business today (let's assume that part goes off without a hitch) would the economy benefit from the increased occupied jobs, or have no net change from a proportional increase in competition?

Or something completely different?
Answer:

There are many assumptions underlying your question. To begin with, we have to ask, why are people currently unemployed? assuming businesses are in it to maximize their profits, then if they are not hiring (which is why there are unemployed...

Question:
So, my question might be more philosophical than economical, but it's wracking my brain and I can't seem to find an answer.

It is about currency and how our money is no longer backed by "gold." Money (i.e. coins and bills) in essence is the same as chips at a casino. At the end of the day, if I choose, I could cash in my chips and get something of value for them. MONEY.

Back in the day, before Jimmy Carter, it was the same way, that, at any time, I could cash in my MONEY for GOLD. (which although has no intrinsic value, is determined to HAVE value.)

So, here is my question.....and I hope I explain it well. A lot of people out there are asking "why can't we just print more money and solve the poverty problem?" Terms like "inflation" and the "devaluing of the dollar" are the usual buzz answers to that question. Also, people give the example that if the government were to print more money and just give everyone $50,000, then everyone would go out and buy things, thus making THINGS more in short supply, thus driving up the price of things. (simple supply/demand economics) But this is where I'm curious. With TRUE unemployment probably somewhere around 15% in this country, if DEMAND rose, then companies would WANT to hire more people and build more processing plants to keep up with demand and raise their profits. So, the influx of cash (printed money) would seem to solve the unemployment problem.

So, here is where I'm confused.....if I apply the same idea of "printing more money and handing it out to the public" to my casino example, then that would be like the casino giving everyone at the poker table an extra $100 in chips to play with. But here's the catch. I understand the PROBLEM with doing that at the casino, because if you give people all these extra chips, then at the end of the night, when people CASH OUT, there will not be enough money in the vault to pay for all the chips. Hence the problem.

But how does that relate to American economics since there is no "cashing out" procedure. If the government gave everyone a bunch more money, there is no "checks and balances" since no one, at the end of the day, goes to the cashier station and exchanges their "chips" (money in this case) for something of value.

Exchanging your chips at the end of the day for MONEY back (which has value in our eyes) makes sense, hence why you can't give out more chips than the money you have in the vault. But it seems the American dollar is not a paper representation of the "money in the vault" no one goes to cash in their money in America.

So I don't understand how currency works and why we can't just print more money since it really isn't representative of anything of value.

Please explain, as I cant find a good answer anywhere online.

(I hope this question wasn't convoluted.)

Thank you so much for your time
Answer:

Let me try to remove some of the confusion. Imagine the only good in the economy is corn and corn costs $1 a pound, and imagine you and all others earn $100 a month. Each month you buy 100 lbs of corn exchanging $1 for 1 lb of corn; so the real...

Question:
This is more of a speculative, hypothetical question. I’m working on a novel in which the wealth of the previous generation is distributed randomly into the next generation. The wealth isn’t distributed equally – in other words, there are the same number of wealthy people from one generation to the other, but there’s no predicting who those new people will be. Once the new generation has the money, they can spend it as they like. So I’ve been speculating – how would that economy look different than our own? Wealthy families wouldn’t be able to pass on wealth – instead, a young person in a slum could be the lucky recipient. What kind of economy would that create?
Answer:

Thank you for your question. The economies would look very different. Your hypothetical world seems analogous to one that imposes a 100% estate tax and uses a lottery to transfer any tax collected back to the economy. Naturally, individuals...

Question:
My wife and I live in the US and are trying to plan for a retirement abroad. We wish to retire to my wife's native Brazil, and one of my principal concerns while we save our nest egg is accounting for the relationship between inflation and exchange rates after retirement, which I do not understand well. The BRL has had fairly high inflation since it's inception in the mid 90's, on average around 7% per year. Due to the inflation of the Real, and my familiarity with investing in the US, I am inclined to leave our assets in USD, and transfer funds into BRL as needed for the duration of our retirement. The exchange rate between BRL and USD also seems to vary wildly, from R$1.50 per USD all the way up to just under $R4.00.

So if we're looking into the future and we predict that the BRL will have an inflation rate of 7% per year, and the USD will have inflation of 3% per year, obviously the cost to live in Brazil will grow much faster than in the US. If that's true, over a period of 30-40 years, in theory, should the exchange rate become more favorable to the USD as the value of the BRL is eroded due to inflation? If so, is there a way I can replicate that effect in my retirement planning? Thank you for hearing my question. Please reach out to my email address if any clarification is needed.
Answer:

First, a disclaimer. Whatever is written below is not actual investment advice; it is general economics discussion, a dinner table conversation, no more.

It is certainly a great thing to be planning your retirement to such a...

Question:
I’m a student at Centennial High School in Pueblo, Colorado. I had a few questions about being an economist. What is it like being an economist? What do you do on a day-to-day basis? What benefits do you get from being an economist?
Answer:

Economics is a science, and the goal of all sciences is to better understand phenomena that we observe in the real world. In social sciences, like economics, the focus is on phenomena related to human behavior; and for economists, the...

Question:
What is the impact of production being directed towards what appears to be endless product differentiation, for example multiple flavours of toothpaste or shampoo variations which ultimately do nothing to improve individual well being? Does this form of market operation generate employment or is it a waste of productive capacity that might be better directed towards activity that genuinely increases well being. For example, creating products that delivers a real benefit.
Answer:

Does the market provide too many or too few products, relative to some social optimum benchmark? It turns out that this question does not have a simple answer. It depends on whether or not consumers are well (perfectly) informed about products'...

Question:
If you have a large amount (lets say 50%) of your wealth tied up in a single foreign currency and your home currency depreciated what would be the effects? Would you be better off or worse off than someone with all their wealth in their home currency? What are the variables that would determine if you are better or worse off?
Answer:

Your wealth in terms of home currency will increase whereas in terms of foreign currency it will decrease. If your home country prices remain the same, it means your real wealth has also increased. So, broadly, it depends on when and where, home...

Question:
I gave an economic presentation the other day and we were talking about how the Chinese devalued their currency to make their exports cheaper to the world, and essentially position themselves better to the American consumer. Someone asked me then why doesn't the U.S. simply follow suit. I answered that every country could not do this because it would end up being a zero sum game and that everybody would eventually lose and that it would not be sustainable. Furthermore, with the U.S. dollar the reserve currency of the world, the amount of volatility in the market place would skyrocket if the U.S. did the same thing. What else could I have said or is there another angle to tackle the question?
Answer:

China’s total trade (exports+imports) as percentage of GDP is about twice that of the US. In this sense, the US is a relatively closed economy and therefore its monetary policy is (and ought to be) more domestically oriented. Second, Chinese...

Question:
I am trying to get an estimate for 2014 arc-co corn and soybean payments for Monona and Harrison counties.
Answer:

ISU Extension has created tools to explore the potential benefits/payments from the programs in the 2014 Farm Bill. These tools are available from www.extension.iastate.edu/agdm/...

Question:
Is it true that large banks can borrow funds at close to 0% interest rates from the Fed and turn around and buy US bonds paying higher interest rates with the borrowed funds?
Answer:

Yes, large banks can in principle borrow funds at close to 0% from the FED and turn around and invest them on higher paying US bonds. But, when large banks do this, they push up the market price of these US bonds (being large players in the...

Question:
Hi there, thanks for taking the time to answer my question.

I understand the basics of measuring GDP based on the product, income, and expenditure approaches, but I am stuck on a simple question: how are household savings accounted for using the expenditure approach if they are not invested?

In other words, say I earn $100, spend $98, and deposit $2 in a non-interest earning savings account. If the $2 (along with a lot more money, presumably) gets lent out to a company that builds a factory, then clearly that would be investment, but what if it just sits in the savings account? Does that count as “residential investment”?
Answer:

There are two components to investment in the national income identity. In addition to expenditure on capital equipment and buildings by firms, investment also includes additions to business inventories (goods that firms did not sell). So if you...

Question:
I watched President Obama’s speech this last week, and I didn’t understand something. He said he’s cut the deficit by 2/3. Yet, we need the debt ceiling raised in order to avoid a government shutdown. Why? If I were to pay down 2/3’s of my debt, I would have a larger amount of credit available to me. What am I missing?
Answer:

You are missing a key difference between the federal budget deficit and the public debt level. The deficit shows by how much the federal government expenditures exceeded its revenues in a given fiscal year; the deficit is measured per year. In...

Question:
In the recent Canadian federal election, the winning Liberal party's platform included running a "small" fiscal deficit of about C$10B each year for 3 years to invest in infrastructure. The commentary about this that most surprised me was this would not increase the accumulated debt, and in fact would still contribute to reducing the debt, albeit more slowly.

Does that make sense? My understanding is that any fiscal year you end up with a deficit means you're borrowing more to make up the shortfall, and thus adding to the accumulated debt. Or are there technical aspects during the year that do otherwise?
Answer:

Given that the standard definition of government spending does not include the repayment of maturing debt, your understanding is correct. In particular, during the three years of running the deficit as planned, the Canadian federal government...

Question:
In corporate finance, operating expenses and capital expenses are tracked separately. Total opex within a fiscal calendar goes against revenues to net at EBITDA. Capex is recorded as fixed assets and amortized over x years to net at net earnings. (I know I'm simplifying things.) Importantly, the company's treasury function provides funding for Capex through a mix of cash flow and issuing debt. This seems clean.

My confusion is how this is reported (at least in public spheres) with governments. When we talk about a government's deficit, we seem to be including operating shortfalls (Opex or where existing programs spending is greater than revenues) plus Capex.

Say my government is running a $10B deficit and no change occurs in revenues and in program spending in the next fiscal year. If they propose a new infrastructure project (say railway) that will cost $$20B starting that year, what would be the deficit? I expect the $20B (assuming it actually stays at that level) would eventually be added to the accumulated debt but only the amortized allocation of it would be recorded as a part of the deficit.

Is that how it's supposed to be? Is that what they actually do? It seems the press never makes a distinction between these, which only confuses the public and obfuscates debate about spending.
Answer:

In your example, the infrastructure investment of $20B will be included in the next fiscal year expenditures in the full amount. Thus, the deficit during the next fiscal year will be $10B + $20B = $30B. Also, the debt level at the end of the next...

Question:
I'm just an average joe, but I thought I had a decent grasp on inflation and top down economics. I don't understand, however, why the cost of EVERYTHING continues to rise in leaps and bounds. Yesterday, I went to Sam's Club and passed on a can of cashews priced at $18. I'm certain last year I was debating whether or not they were worth $13. I'm almost certain that the cost of picking and packing nuts hasn't increased that dramatically; how can they justify an almost 50% increase in price? I've noticed that the cost of eggs has increased everywhere; a dozen eggs are almost $4, the expensive ones used to be $1 and some change. Am I to believe it costs 400% more now than it did five years ago for chickens to lay eggs? The cost of butter has increased at the same rate of eggs, so I can see whatever is affecting the chickens are affecting the cows as well... This question was prompted when I noticed that the $18 cashews were close to the same price as the honey which was comparable to the price of shrimp. No way you can tell me it costs the same to harvest honey, nuts and shrimp! For whatever reasons I know that the cost of gasoline has increased 400% since I first started driving less than twenty years ago; although it is declining significantly now, but why does a gallon of milk cost more than a gallon of gas? Who is controlling this stuff?
Answer:

Let me answer the last question first. The markets are controlling the prices, based on supply and demand. So, depending on how you want to look at it, either everyone or no one is controlling the prices. Let’s dive into the factors that have...

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