Category: Economics

Even if mileage values held constant, I’d rather spend miles now instead of money to get my tickets… and invest the money I saved for retirement (or something else). Money earns a rate of return when properly invested.  Airlines have never paid a return on miles held in an account.

But mileage values won’t hold constant. All we need to see that is a basic monetarist formulation, the very mv=pq that college freshman learn, without any other fancy tools.

If the quantity of airline award seats remains the same (because airlines aren’t growing capacity) or quantity is even going down (because airlines are selling the seats) while new miles are printed faster than they’re redeemed, prices rise.

Airline bankruptcies have sped up the rate at which awards are being redeemed. When loyalty program members are uncertain about the future of their points you get a run on awards — United and USAirways both experienced this when their frequent flyer members believed they needed to cash in their points while the airline was still around. Both lasted in the end, in USAirways’ case in spite of near-universal pundit predictions. But many frequent flyer program members didn’t wait — they wanted to travel for fear of winding up with nothing.

On the whole, though, 8% of airline seats go to award redemption (over time and across programs), and this has remained fairly stable.  But while the quantity of award seats being redeemed stays fairly constant, the quantity of miles outstanding rises.

Unfortunately, additional award seats aren’t made available and consumers simply experience more miles chasing a fixed pie of seats.

That’s why prices of awards do and will rise.

But airlines, especially in financial jeopardy, are loathe to alienate their best customers (the ones most likely to be earning mileage) through price increases, so we see some selective increases and also award seat shortages. Instead of achieving a new equilibrium by raising prices, airlines frustrate customers in a different way, turning them away when they look for awards.

(By the way, the Capital One ‘mileage cards’ are about the worst credit card decision you could make outside of earning no reward at all, that will be the subject of another post in the next few days).

Here’s where I part company with the rest of the pundits: this inflationary future does not mean you should walk away from mileage programs. It just means that you should earn and burn miles in the same period to the extent you possibly can. Don’t save for retirement, spend your miles just as quickly as you earn them before prices rise.

As for me I do have a seven figure mileage balance but I also spent 675,000 miles on a single three week vacation this summer.

This advice won’t change until Alan Greenspan decides that for a retirement job he’ll become the head of Mileage Plus (and Paul Volcker takes over AAdvantage).

Jonathan Klick (a co-author of mine) and Thomas Stratmann (a colleague at GMU) have written an interesting paper on abortion and risky sex among teenagers.  From their conclusion:

Incentives matter. They matter even in activities as primal as sex, and they matter even among teenagers, who are conventionally thought to be relatively myopic. If the expected costs of risky sex are raised, teens will substitute toward less risky activities such as protected sex or abstinence. In addition to modeling the decision making processes of teenagers, this insight is important in other contexts as well. Many public policies can be improved by recognizing the sensitivity of teenage sexual decisions to costs and benefits.

We study one set of policies in this paper. We show that increasing the cost of abortion for teens lowers the insurance value of abortion. This induces teenage girls to avoid risky sex, which will likely have the effect of lowering pregnancy rates, abortion rates, and birth rates among this group of individuals. While these positive effects alone might not justify parental involvement laws, they presumably should not be ignored in the debate. Behavior is not static, and claims based on the assumption of static behavior are flawed.

Charitable organizations have long made it possible to sponsor a child in a poor country.  Kiva lets you sponsor a business in a poor country.

By choosing a business on our website and then lending money online to
that enterprise, you can "sponsor a business" and help the world’s
working poor make great strides towards economic independence.
Throughout the course of the loan (usually 6-12 months), you can
receive monthly email updates that let you know about the progress
being made by the small business you’ve sponsored. These updates
include reports on loan repayment progress, photos of new capital
equipment, narratives on business growth and standard of living
improvements, and more. As loans are repaid, you will get your original
loan money back.

Kiva has recently been discovered by the web and so they are currently out-of-businesses to sponsor (which is a good sign), but it’s a great idea and I intend to sponsor a business as soon as one becomes available.

Thanks to Pablo Halkyard for the pointer.

Brad DeLong asks:

This is one of the most puzzling puzzles in macroeconomics: that foreign-exchange speculators are not very good at linking domestic money and bond markets to the foreign exchange market. Not enough money seems to be engaged in betting that a currency with a high nominal interest rates will not decline in value fast enough to make investing in its securities unprofitable. Why not? It’s an easy thing to do.

James Hamilton [correction: *Menzie Chinn*] adds more.  What are the main hypotheses for why high nominal interest rate currencies appear to outperform the market?

1. The so-called "peso problem."  Someday the roof will cave in on these currencies.  The Asian financial crisis was only a small disruption compared to what will happen someday.  Our current data set is incomplete and does not represent the real population.

2. Holding crummy currencies is riskier than CAPM and variants indicate.  Most likely, the relevant investors are not and cannot be well-diversified.  So their high pecuniary returns are offset by the risk they bear.  If thirty percent of your wealth is in the South African Rand, the relevant measure of your risk may be the variance of that currency, not the covariance of that currency with some broader international market portfolio.  Economic theory usually measures risk by looking at the latter.

3. Many investors stay away from crummy, high nominal interest rate currencies for fear of what their wives (or bosses, consider an agency problem at a financial firm) would say, should they lose money.  The relevant markets are segmented.  This is linked to #2.

4. This used to be a puzzle, but now the profit opportunity has been identified.  The supposed additional risk of the high nominal interest rate currency is phantom.  People now jump into high nominal interest rate currencies, at least when such investments are appropriate to restore an equilibrium of risks and returns.  We should expect the paradox to disappear in future data sets.

Observation: Do not ever write or say "CAPM model."  Do not ever write or say "ATM machine."

Wages for low-wage workers have been flat in recent years but health care costs have been increasing.  For a company like Wal-Mart, which pays many of its workers modest wages but does offer a reasonable health insurance plan, this is an invitation to adverse selection.  As the value of the wage component of the Wal-Mart benefit package has declined relative to the value of the health insurance component Wal-Mart has attracted more workers who want the job for the health benefits, i.e. sicker workers.  Reed Abelson writing in the NYTimes notes:

The Wal-Mart work force reflects a growing fear of many employers that the
people who work for them are increasingly at risk for health problems. Many of
Wal-Mart’s employees are obese, the company says, and a result is rapidly rising
numbers of cases of diabetes
or heart
disease. The prevalence of these diseases among Wal-Mart employees is
increasing much faster than the national average, it says.

"The low-income population generally is not as healthy and does not engage as
much in preventive care," said Diane Rowland, executive director of the Kaiser
Commission on Medicaid and the Uninsured. A risk that a company like Wal-Mart
faces, especially when it competes with smaller retailers that offer no
insurance at all, Ms. Rowland said, is attracting too many workers who want the
job primarily for the health coverage.

Wal-Mart’s health care costs are rising faster than their revenues.  Other companies are trying to shift some of the cost of health care onto their workers but Wal-Mart’s workers are already paying more than the national average so Wal-Mart may try to reverse adverse selection by adjusting their work and benefit package.  An internal memo suggests that:

…the company could require all jobs to include some
component of physical activity, like making cashiers gather shopping carts. It
also recommends redesigning and expanding benefits to appeal to a different type
of worker, someone more interested in buying a home, say, than in getting health
insurance.

Wal-Mart will probably be pilloried for this sort of thinking but you can hardly blame them when the workers are engaging in almost the identical actions in reverse.  The more fundamental problem is the tying of insurance to work, a problem for which I am afraid there no win-win solution.

Comments are open.

Addendum: Rey Lehmann offers excellent commentary.

Here is a list, thanks to Craig Newmark for the pointer.

Here is question number two, if you are bold try to sketch an answer in the comments.

Let us say you had a real business cycle model where production took a very long period(s) of time, rather than just a single (shorter) period.  Might this help such a model explain the aggregate macroeconomic data?  What might become easier and what might become harder?

Hint: One good approach is to break your answer down in the three categories of "comovement, persistence, and labor supply."

I associate Ben Bernanke with several major contributions:

1. The theory of irreversible investment, circa 1983.  Before Bernanke, Dixit, and Pindyck, models often assumed that investments could be reversed or "taken back."  Bernanke outlined how the irreversibility of investment might matter.  Often individuals will choose to wait and sample more information, rather than make an immediate decision.  Small changes in information could lead to big fluctuations in investment.  Large changes in interest rates might have little effect.  Bad news can hurt you more than good news helps you.  This was Bernanke’s first major contribution to economics.

2. The credit channel for monetary policy; here are the papers, most of all the 1992 piece with Alan Blinder.  Bernanke took an old Keynesian idea and gave it empirical rigor.  During upturns and downturns, does money or credit play the leading role?  Bernanke showed that credit has greater importance.  Bernanke’s work in particular helped combat the Litterman and Weiss paper of 1983; L&W had showed that once you put the nominal interest rate in a Vector Autoregression (a relatively atheoretical statistic technique), money didn’t seem to matter.  Bernanke rescued the relevance of money but showed it mattered through the associated channel of credit.  This work stands among the most important contributions in macroeconomics in the last twenty years.  It also suggests that Bernanke, as Fed chair, will look closely at credit indicators.  Here is a Bernanke speech on money and the stock market.

3. Inflation targeting. Very few if any economists will now defend the old Friedmanesque recipe of monetary targeting or a fixed rule for money supply growth.  It has become increasingly popular to look toward inflation targeting.  New Zealand and Canada led the way in terms of policy when their central banks explicitly adopted a range for inflation targeting; 0-2 percent in the case of New Zealand.  Bernanke would like to see the Fed put greater emphasis on price stability.  He did not invent this view, but he is the individual who made it politically credible.  Right now the major debate in the theory of monetary policy concerns whether inflation targeting should be tight or loose.  Bernanke has been a major force on these issues, and he has often been praised for his leadership in this area, even by those who disagree with him.  Here is a 1999 Bernanke essay on inflation targeting.

4. Causes of the Great Depression; here is one paper, here is part of his book.  Bernanke did a good deal of comparative work and concluded that the Great Depression became great because of deflation, its international transmission, and rigid exchange rate policies.  Recall that Sweden, which cut the link from gold and let its currency float, had a much milder depression during the 1930s.  This has become part of accepted wisdom; in a policy context it implies Bernanke has a low tolerance for deflation.  Here is a Bernanke speech on the Great Depression.  Here is an Anna Schwartz review of his book.

5. The global savings glut.  Trade and budget deficits are enormous, so why aren’t we collapsing?  Why do real interest rates remain so low?  Bernanke cited the possibility of a global savings glut; here is one explanation of the idea, here is another.  The bottom line is this: some Asian countries have high levels of savings, but poor financial institutions.  They invest their savings in the United States, and often we invest in back in Asia.  In essence they are "outsourcing" their savings to foreign financial institutions.  This recycling of Asian savings may help explain what is going on in the global economy.  It also suggests that the current U.S. position is at least temporarily sustainable.  Here is a relevant Bernanke speech; here is some commentary on the idea.

Here is Bernanke’s vita.  Here are his books.  Here is his talk on making the transition from academic life to the policy world.  Here is a White House bio.  Here is Wikipedia.

Bernanke the man? I met him once and had lunch.  He came across as a nice guy; most importantly, he listened to everyone at the table (or at least seemed to!), no matter what their academic status.  In the profession he is popular.

If you know more, comments are open.  Here are various blogger reactions.

The new Fed nominee is Ben Bernanke, an excellent choice and a first-rate economist. 

What must a good Fed chair do? 

1. He should have a mastery of data and an understanding of the macroeconomy.  He must not be a dogmatist.  Bernanke gets an A or A+ here.

2. He should have the ability to lobby the President and Congress for support.  It is not clear who is listening but Bernanke gets in relative terms at least a B+ here.

3. He should have the personality to hang tough.  This requires the "test of time" but we have no reason to be pessimistic.

4. He should recognize that the Fed can only succeed if fiscal policy is responsible.  Give him an A.

5. He should be credible abroad and on Wall Street.  Bernanke is not fully senior in this regard, at least not within the policy community, but he could achieve this stature within a year’s time.  B.

6. He should have that Greenspan magic touch.  Grade?????

Next I will post on Bernanke’s contributions to economics.  Comments are open…

Word is that a successor to Alan Greenspan — or at least the Bush nominee — will be announced later today.  Check back for a report.  Comments on this post are open in case you beat me to the news; I do have a lunch coming up, plus many of you are excellent analysts anyway…

Milton Friedman has long suggested that the social responsibility of business is to maximize profits.  Recently he tried to clarify this view:

I shall try to explain why my statement that “the social responsibility of business [is] to increase its profits”…

Note first that I refer to social responsibility, not financial, or accounting, or legal. It is social precisely to allow for the constituencies to which Mackey refers. Maximizing profits is an end from the private point of view; it is a means from the social point of view. A system based on private property and free markets is a sophisticated means of enabling people to cooperate in their economic activities without compulsion; it enables separated knowledge to assure that each resource is used for its most valued use, and is combined with other resources in the most efficient way.

Of course, this is abstract and idealized. The world is not ideal. There are all sorts of deviations from the perfect market–many, if not most, I suspect, due to government interventions. But with all its defects, the current largely free-market, private-property world seems to me vastly preferable to a world in which a large fraction of resources is used and distributed by 501c(3)s and their corporate counterparts.

Friedman has qualified his social responsibility claim for force and fraud, but what about negative externalities more generally (just ponder Tamiflu licensing if you want the appropriate headache)?  Is Friedman’s claim:

1. Profit maximization is the best rule available, even though it fails society in particular instances (in that case, isn’t there some slightly more convoluted rule that can cover at least some of these situations and modify the outcomes?  If only "very simple" rules are allowed, why?)

2. Businesses have no responsibility to behave in an act utilitarian fashion.  Rules are rules, and we should follow them, come what may.

3. Following the doctrine of fiduciary responsibility — in this case to shareholders — is the greatest social good in these situations.  It outweighs potential act utilitarian considerations pointing in other directions.

4. Force and fraud aside, profit maximization always coincides with the social good, at least in the absence of bad government interventions.

5. It is a public choice argument.  The claim is a noble lie, for otherwise business will be regulated by government in a counterproductive manner.

6. So much anti-corporate nonsense has been written, so we need to shock people with an extreme claim in the opposite direction.

In response to Friedman, John Mackey, the CEO of Whole Foods, argues: “I believe the entrepreneurs, not the current investors in a company’s stock, have the right and responsibility to define the purpose of the company.” 

My take: No simple rule can sum up what is right to do, for a business or otherwise.  So I have to read Friedman as falling back on #5 and #6, with his partial belief in #4 convincing him he needn’t worry about the complications so much.

Forget about avian flu, I hate waiting in line to board a plane.  But what is the answer?

United Airlines says it believes it has hit on a better solution. It recently announced a logistics ploy it calls Wilma – shorthand for window-middle-aisle – that it claims will cut boarding times by four to five minutes, an eternity in the industry’s on-time takeoff sweepstakes. The idea is to fill the window seats in economy class first, then the middle seats, then the aisle seats, thereby eliminating the free-for-all chaos that clogs the cabin when passengers are sent in by row numbers.

Southwest, of course, eliminates the whole idea of assigned seats.  Or how about some economics?  Charge people for each carry-on, since the bag makes it harder to board (and get off) quickly.  Or have an electronic record of when people manage to reach their seats and buckle their seatbelt.  The sooner you buckle, relative to your position in the plane of course, the greater your chance of a prize or rebate.  Small ideas for a much better world, as they say.