Government

EYE ON THE PIE: Who needs economists, anyway?

July 17, 2006

Economists are not stupid people. They are timid and tend to hide their timidity behind a wall of overbearing self-confidence. But they are not stupid. In fact, often they are too smart to talk about what they do and do not know. As they wiggle over the rocks of uncertainty, they appear to others as either sneaky or formless.

Let's take interest rates as an example. Economists like to talk about how, if the Fed raises interest rates, home mortgage rates will rise, and new and existing home sales will decline, leading to fewer sales of furniture and appliances. This is one of many favorite domino games.

The Fed is what economists and journalists call the Federal Reserve System; that's akin to my calling Houston Astros pitcher Roger Clemens, "Roger." It suggests a familiarity that does not exist.

What the Fed really does is raise its target on one rate known as the Fed Funds rate-the rate of interest banks pay one another to borrow money they have on deposit at the Fed. But that's just a target and not the actual or effective rate.

For example, for most of June, the target was 5 percent, but in the final week of the month, the effective rate was above 5 percent. This means market forces were pulling the Fed Funds rate up. Why? Either the market was anticipating that the Fed was going to raise its target and lenders wanted to get a head start on a higher rate, or borrowers were eager to borrow at lower rates before the Fed raised rates.

But who knows? What we know is that the Fed cannot hit its targets perfectly and might not care if it does not. The Fed is sending signals to the market on which direction we need to go to maintain price stability. Inflation (or deflation) is the real concern of the Fed, which was established to protect people who put their money into banks and people who lend money with the expectation of being paid back in dollars that are not worthless. It has been a major issue in the United States going back to George Washington, Alexander Hamilton and Andrew Jackson.

In 30 seconds of air time, economists cannot discuss these matters. Even in 30 minutes on PBS, economists will shy away from the truth. Because we really don't know how long it will take for a change in Fed Funds rates to have an effect on mortgage interest rates or on the housing market. Is it three months, six months, 16 months? "Well," we say, "it all depends." Then we have a list of factors on which it depends, a list that is neither constant in content nor consistent in consequences.

The same things could be said about gas-price increases. When will the economic "laws of supply and demand" come to play in this market? The answer is "eventually." Now run your business with that advice.

The quantities of petroleum demanded should decrease as prices rise, but it takes time for people to make the adjustments in their driving behaviors and the types of vehicles they own. Similarly, it takes time for new wells, pipelines and refineries (plus alternatives to petroleum) to be brought online to increase supplies. How long? Who knows?

This uncertainty does not provide answers for policymakers. Hence, the successful economist will be without doubt. Policymakers, in business or government, need this certainty. They have a job to do and a dithering economist is not helpful.



Marcus taught economics more than 30 years at Indiana University and is the former director of IU's Business Research Center. His column appears weekly. To comment on this column, go to IBJ Forum at www.ibj.comor send e-mail to mortonjmarcus@yahoo.com.
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