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Does the information available on the Internet make for a more efficient stock market? Not the way I see it.

I believe that the spectacular rise and fall of the stock market in the United States in the last several years can be attributed to the behavior of swarms of investors that were fostered by the Internet. We might call these "dumb mobs."

Discussion Question. Robert Shiller, author of Irrational Exuberance, is another economist who believes in mob behavior. This theory implies that in the long run stock returns will exhibit mean reversion--periods of unusually high returns will be followed by periods of unusually low returns. How does this hypothesis violate the theory of efficient markets?

Brad DeLong argues that interpreting Fed policy by watching monetary aggregates is pointless.

The problem with vulgar monetarism--in all of its different and contradictory branches--is that it never acknowledges that different measures of the money stock frequently say different things. The M1 and M3 measures of the money stock were giving wildly different assessments of the state of monetary policy in the late 1990s.

Instead, he points out that real interest rates are a much better indicator of both the intent and impact of monetary policy. That is, you see high real interest rates when the Fed is trying to slow the economy and low real interest rates when the Fed is trying to stimulate the economy.

Discussion Question. Recently, the real interest rate on Federal Funds has been below zero. Does this mean that the Fed is stimulating the economy? If so, has this been successful?

Thomas Friedman says that we should be happy with our government, because our officials are not as corrupt as in other countries.

Indeed, what foreigners envy us most for is precisely the city Mr. Bush loves to bash: Washington. That is, they envy us for our alphabet soup of regulatory agencies: the S.E.C., the Federal Reserve, the F.A.A., the F.D.A., the F.B.I., the E.P.A., the I.R.S., the I.N.S. Do you know what a luxury it is to be able to start a business or get a license without having to pay off some official?

However, Carl Pope and Ed Crane do not take such a favorable view of Congress and pending energy legislation.

The legislation does nothing to improve the efficiency of energy markets or to remedy any market failures. In fact, it makes matters worse by further distorting these markets with billions of dollars of taxpayer subsidies and other handouts to well-connected energy industries.

This shouldn't come as any surprise. When politicians lack the courage or wherewithal to solve problems, they reflexively subsidize politically potent industries that supposedly offer solutions.

Lynn Kiesling makes the case that markets regulate effectively when left alone. She takes on the politically popular "corporate reform" legislation.

Regulated transparency would not benefit companies, investors and consumers to the extent that the existing market mechanisms do. Imposing further regulated transparency beyond existing SEC regulations would weaken the network of private incentives that generate long-run efficiency through communicating information among firms, investors and consumers about their ideas, costs and resources.

I believe that Thomas Friedman makes an important point that there is a much lower "bribery tax" in America than in many other countries. And we have some regulatory agencies that are reasonably pure in the way they pursue their missions. However, Kiesling is correct in that the private sector often moves more quickly and flexibly to solve problems than does the legislative and regulatory structure.

Discussion Question. Libertarians argue that excessive government regulation reduces private sector vigilance. Could the private sector step in if, say, government meat inspection were discontinued?

Popular legislation on prescription drugs may include a provision allowing U.S. sellers to import prescription drugs from Canada at low prices. 'Jane Galt' examines the economic consequences of such a provision.

Canada's prices could drift upwards towards ours... because drug companies are unwilling to sell at a low price in order to secure the paltry Canadian market. Canadian consumers will be forced to pay the same price we do, and all those people who have been screaming about the wonders of single payer health care are going to find that their fact sheets suddenly look a lot less attractive...

Only there's one little problem with the model: the government is not a normal market...

If drug companies try to charge the Canadian government what they charge Aetna, the Canadian government can do what Aetna can't: authorize companies to legally produce generic substitutes.

'Jane Galt' says that Canada's ability to threaten to break patents will give that country the negotiating leverage to maintain low prices. That in turn will cause reimportation to wreck the economic model for pharmaceutical research.

Discussion Question. What would happen if the private sector stopped funding drug research? How might government funding be different ('Jane Galt' touches on this issue)?

in the early 1980s it was above 7%. But in the mid 1960s and today it has reached a trough of 4.5% or so.

I think, and I believe that DeLong would agree, that a big reason for the movement in the NAIRU is productivity. When productivity growth is below trend, as it was in the 1970's and 1980's, workers' wage demands are unrealistically high. When productivity growth is higher, firms can raise real wages and still maintain high levels of employment.

Discussion Question. How would a strengthening dollar have contributed to lowering the NAIRU?

Brad DeLong uses an old analytical tool, called Okun's Law, to argue that potential GDP is growing at a 3.5 percent rate.

Over the 1960-2001 period, real GDP grew at an average rate of 3.4% per year. When unemployment fell, GDP grew by more--a 1%-point fall in the unemployment rate being enough to push the annual rate of GDP growth up by 2%-points; a 1%-point rise in the unemployment rate being enough to push the annual rate of GDP growth down by 2%-points.

By taking out the 2-for-1 relationship between GDP and unemployment (Okun's Law) and doing some smoothing, you can arrive at an estimate for growth in potential GDP. This is an entirely empirical estimate, with no analysis of the underlying causes of growth in potential GDP. It tells a convincing story of the past, but not the future. If you are going to forecast growth in potential GDP, then it seems to me that you have to forecast its components, which are labor force growth, growth in the capital-labor ratio, and growth in what used to be called "the residual" (driven by technological change, education, and so forth).

Discussion Question. Because of high rates of immigration in the 1990's, the labor force grew more rapidly in the United States than in other developed countries. Is this likely to continue?

In this column, I talk about Moore's Law and its implications for shared-spectrum wireless.

Moore's Law is the most powerful economic discovery since compound interest...

The way I see it, Moore's Law ultimately will favor shared-spectrum wireless as the solution for last mile connectivity. Today, I am typing this out on my porch, using a laptop that connects wirelessly to a router in my basement, which in turn connects to the local phone company by DSL. My prediction is that eventually I will skip the DSL part, and instead my wireless connection will go to a local wireless network of some sort, and then ultimately to a transmitter on the Internet backbone. The communication network will have a fiber skeleton and a wireless skin. Telephone land lines will be superfluous.

Discussion Question. Most economic measures only double after decades. Moore's Law sasy that computer processing capability doubles in less than two years. What does this imply for the trend of the share of computer processing in economic output?

Bruce Bueno de Mesquita and Hilton L. Root argue that autocratic governments have incentives to follow economic policies that are not in the interest of the average citizen. Leaders whose power base is inclusive of wide groups of the population remain in power longer if they promote economic growth. However, the opposite is true for leaders who have a narrow power base.

[Autocrats] who rely on black-market corruption have a better chance of staying in power than those who engender high rates of growth, staying in office, on average, 25 percent longer. Indeed, at all periods during their tenure in office, these leaders do much better at retaining their jobs if they promote black marketeering, corruption and cronyism--distorting the economy--than if they promote economic policies that lead to growth and prosperity.

Discussion Question. What does this analysis suggest about the economic consequences of giving aid to autocratic regimes?

State governments tend to pump money into the economy when times are good and suck money out of the economy when times are bad. As the Washington Post reports, we see that happening today.

As of April, more than 40 states had instituted some kind of spending freeze or modest across-the-board cut, according to a survey by the National Conference of State Legislatures (NCLS). About 29 states cut spending on higher education, 22 cut Medicaid funds, 25 cut their corrections budgets and 10 laid off some workers.

When the stock market was near its peak, In January of 2000, I wrote this warning about macroeconomic consequences of a stock market crash, and I talked about state government spending as an issue. In a subsequent essay, I specifically recommended that if my fears about the market and the economy were borne out then the Federal government should enact a $280 billion revenue-sharing plan for the states. It is time to consider that recommendation.

Discussion Question. Does it make sense that state governments are not allowed to run deficits, but the Federal government is allowed to run a deficit?

In the Wall Street Journal, Arthur Laffer looks at interest rates, profits, and stock prices, and concludes that stocks are a bargain.

For those who like price/earnings ratios, the conclusion is simply that stock prices are uncommonly low when compared to bond prices and properly reported corporate profits. The price of a bond in relation to its coupon is not only the inverse of that bond's yield, but is itself a price/earnings ratio. When yields on bonds fall, price/earnings ratios should rise. Given what's happened to interest rates, price/earnings ratios should also rise. But as of today, stock prices have not only not risen, they have fallen way out of line with corporate profits and the current level of interest rates.

This formula is erroneous, as was pointed out by Franco Modigliani and Richard Cohn in 1982. The ratio of profits to stock prices is a real (inflation-adjusted) magnitude. The 10-year interest rate is a nominal (unadjusted) magnitude. If we subtract expected inflation from the interest rate, we adjust the "fair market value" of stock prices higher at all times. However, the adjustment is of a larger magnitude historically than it is today.

Here is another way to get historical perspective on the stock market. Simply compare the ratio of the S&P 500 stock index to nominal Gross Domestic Product.

For today's figures, I used first quarter GDP and the S&P 500 as of about 3:30 PM this afternoon. The ratio is below what it was in 1960, but still higher than what it was from 1970 - 1990.

The ratio of earnings to prices for the stock market today is less than 4 percent. The real rate of interest on Treasury inflation-indexed bonds is about 3.5 percent. So there is no overwhelming evidence that stocks are a screaming buy. Nonetheless, I think that there is a case to be made for a scenario in which the U.S. economy grows unusually rapidly over the next decade--Brad DeLong makes that case well. If so, then the stocks should do well. In the last couple of weeks, I have begun to shift out of bonds and into stocks. Since the end of 1996, I had been moving in the opposite direction.

Discussion Question. Does the drop in the value of the dollar suggest that it is overseas investors who are pulling out of U.S. stocks?