I’ve decided to put my posting at A Blog of Marginal Benefit on hold for now, in order to cover economic topics more generally at my own website, http://parkersheppard.com. I’ve reposted most of my earlier ABMB posts on my personal site. Stay tuned to my blog or my Twitter feed to find out when ABMB will be up and running again.

Joel Waldfogel, in his new book Scroogenomics: Why You Shouldn’t Buy Presents for the Holidays, argues that we should give up giving gifts at Christmas time because we inevitably waste money on gifts that others don’t want. From the publisher:

When we buy for ourselves, every dollar we spend produces at least a dollar in satisfaction, because we shop carefully and purchase items that are worth more than they cost. Gift giving is different. We make less-informed choices, max out on credit to buy gifts worth less than the money spent, and leave recipients less than satisfied, creating what Waldfogel calls “deadweight loss.”

I’ll admit that I haven’t read the book, so there may be more to Waldfogel’s argument in the book, but I have a few issues with the main thesis.

First, the actual economic transaction between the retailer and the gift-giver creates value. When we go to the store to purchase a gift, say for $20, we value giving that gift more than the $20 we use to purchase it. So, without taking into account how much the receiver values the gift, the transaction creates positive economic value.

More generally though, by focusing on gifts as a method of allocating resources, Waldfogel misses the point of giving gifts at Christmas. The Christmas gifts we give each other symbolize the gift humanity received from God. As Dan Ariely points out in Predictably Irrational, the symbolic exchange of gifts is a perfectly rational exchange, governed not by a market mechanism, but by social expectations. Indeed, under the assumption that individuals maximize value, no one would ever give away anything of value for free. Economists like to think of people as rational utility-maximizers, mostly to simplify mathematical models. That assumption doesn’t always hold.

However, Waldfogel does correctly discern that individuals can choose best what goods benefit them the most. His logic applies to government welfare programs that collect taxes in order to spend money on goods that people may or may not want.

Today marks the 45th anniversary of the broadcast of “Rendezvous with Destiny,” a recording of Ronald Reagan’s speech at the 1964 Republican National Convention. I’ve heard the speech many times, and every time I listen to it, it continues to amaze me. Watch the whole broadcast, embedded below:

So I managed to let the one year anniversary of my first post pass by without any fanfare.  It’s hard to believe that it’s been one year since I started writing.  I’ve learned a lot about writing and I hope that those of you who have read my posts learned something from them as well.

For the second year, I want to make a few changes to the format of the site.  My original approach to writing seemed a little too formal and stale.  From now on, I’m going to let a little more of my personality show in the site.  I have opinions on a lot of subjects besides economics, and over the past year I’ve found myself wanting to write about them just as frequently.  Expect to see more posts on politics, philosophy, statistics, and mathematics.

I also read a ton of new stories online.  I’m no Matt Drudge, but I’d like to think that I come across articles that others would find useful pretty frequently.  I’ll add more posts simply linking to other articles when I don’t have the time to write up a full post.

Speaking of time, I haven’t had as much of it for this site as I would have liked in the last few months.  With a full load of graduate school courses plus an internship and a teaching assistantship, I just simply haven’t had the time to update as frequently as I would have liked.  I’m going to make time for this site, so please check back more frequently.

Finally, I’d like to thank you for reading what I have to say.  It means a lot to me that you’ve passed up time you could have spent reading other material elsewhere.  If you do find my writing informative, please feel free to share it with your friends.

In order to support the banking system, the Federal Reserve has creatively expanded its balance sheet, the list of its assets and liabilities.  Generally, the Fed holds two types of assets — government securities and discount loans, the loans that it makes overnight to other banks — and two types of liabilities — currency in circulation, the green pieces of paper in you wallet that say “Federal Reserve Note”, and reserves, both the amount that banks are required to keep in reserve with the Fed and any excess amount of reserves.  The liabilities of the Fed are referred to as the monetary base.  The monetary base is the primary, though not the sole, determinant of the supply of money.  When the Fed’s liabilities increase, the monetary base and therefore the money supply increases.  In the past few months, the Fed has expanded its holdings of securities, purchased or accepted as collateral new types of assests, and created new lending facilities to facilitate the flow of credit without expanding the supply of money.

How the Balance Sheet Works

The Fed controls the supply of money by buying and selling securities, a process known as open market operations.  When the Fed buys a security from a bank, it lists the security as an asset on its balance sheet, and credits the bank’s account with the corresponding dollar amount, increasing its liabilities because the bank can withdraw currency from its account at any time. When the Fed sells a security, the process works in reverse; it takes an asset off of its balance sheet and receives a payment from the bank, which reduces its liabilities.  In short, when the Fed buys securities it increases the money supply and when it sells securities is decreases the money supply.

The same logic applies to the Fed’s other main type of asset, loans to the banking system.  The loans are an asset for the Fed because it expects banks to repay the loan funds.  Correspondingly, the loaned funds are either placed in reserves or exchanged for currency, so they incease the Fed’s liabilities and the monetary base.

Expanding the Balance Sheet

The chart below shows data from Federal Reserve Statistical Release H.4.1 — Factors Affecting Reserve Balances.  I’ve selected dates from August 2007, right before the initial liquidity crisis; July 2008, the first appearance of loans to Maiden Lane, LLC, the corporation set up to dispose of assets from Bear Stearns; September 2008, after the collapse of Fannie Mae, Freddie Mac, and Lehman Brothers; November 2008, after the Fed announced and implemented many of the new lending programs; and the most recent release on December 18, 2008.

Over the time of the crisis, the Fed has created new lending programs — the Term Auction Facility, the Commercial Paper Funding Facility, the Money Market Investor Funding Facility, the Maiden Lane LLCs, the Primary dealer credit facility, and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility — with $840 billion in loans, worth about as much the the Fed’s holings of securities before the crisis.  The Fed’s primary credit facility has grown from $2 million in August to $88 billion in December, a 4,240,150% increase.  The Fed’s total assets have grown from $909 billion to $2.3 trillion, a 153% increase.  Ordinarily, an increase in assets like this on the Fed’s balance sheet would lead to a correspondingly large increase in currency in circulation or new loans from banks.  Any increase in the monetary base leads to roughly a 10% expansion in the money supply.  Yet currency in circulation is only up 7% from August 2007 to December 2008 and the price level, as measured by the Personal Consumption Expenditures (PCE) index, is only up 3% from August 2007 to October 2008.

The Fed Giveth, and the Fed Taketh Away

That’s because Fed has been just as creative in finding ways to pull money out of the banking system at the same time it has pumped extra funds in with new loans.  Part of the Emergency Economic Stabilization Act of 2008 included accelerating the implementation of a rule that lets the Fed pay interest on the excess reserves that banks hold.  Notice how reserves have grown from $12 billion in August 2007 to $800 billion in December 2008, a 6,471% increase.  The new rule lets the Fed minimize both the inflationary effect and the increased risk associated with the new loans.

The Fed has also used its standard method for pulling money out of the banking system, selling securities, to prevent a rapid increase in the money supply. It has sold 38% of its securities holdings over the length of the crisis.  But the $790 billion portfolio the Fed had at the start of the crisis wasn’t nearly enough.  To make sure the Fed held enough in securities, the Treasury created a Supplementary Financing Program in which it issues new debt and deposits the proceeds in an account with the Fed.  As of December 2008, the balance in the account stood at $364 billion.  The general account has also expanded from $4 billion to $79 billion.

The Hidden Bailout

The good news is that credit is flowing again.  The new actions by the Fed and the Treasury take excess funds from the public, route them through the Treasury and then to the Fed, who provides them to the financial institutions who need them.  Funds move from those who have an excess to those who need them, just like they should in any properly functioning financial market.  In fact, since Treasury debt is in high demand now because of its safety, the Treasury can borrow at a low interest rate and deposit that money in the Federal Reserve, who is loaning money to banks at a high interest rate.  Since the Fed remits most of its profits to the Treasury, the taxpayers stand to make a good profit on the spread between the two interest rates.

The bad news is what might happen if some of the borrowers default on their loans and the money doesn’t flow back in the proper way, from the borrowers, to the Fed, to the Treasury, and back to the original lenders.  The United States government is not going to default on its debt, so that means that any losses that occur from these new loans go to the taxpayers.  The government will recover losses will either through increased direct taxation in the form of higher tax rates or indirect taxation though printing new money and deprecating the value of the dollar.