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Bob Frankston does not care for a pricing model in which a connectivity provider obtains a share of revenue from business transactions conducted using its service.

What gives ATT the right to grab revenue from a company just because it uses their wires? Imagine if ATT insisted on taking a cut of every transaction done over its phone lines!

In the market, any voluntary contract between consenting adults is legitimate. If a business would rather pay for Internet service by sharing its transaction revenues than by paying a flat rate, then neither Frankston nor anyone else should try to stop them.

I think that what Frankston would say is that no consenting adult would agree to share transaction revenues with an Internet provider, unless that provider were a monopolist that gave you no choice. That may be what is happening here, in which case the challenge is to regulate monopoly profits, regardless of how ATT chooses to extract them--through transaction revenue sharing or simply by charging exorbitant rates.

Discussion Question. Monopolists tend to gain through price discrimination. Why might transaction revenue-sharing help to facilitate price discrimination? Is this form of price discrimination adverse for the economy as a whole?

Brad DeLong sees the silver lining in the cloud of a weak economy.

By late 2002 (according to our projections, at least) real GDP will be some ten percent higher than it was four years earlier. When you reflect that the U.S. economy is running much less "hot" today than it was in 1999--compare the then-unemployment rate of roughly 4 percent to today's unemployment rate of roughly 6 percent--you come up with the consensus guess that the productive potential of the American economy today is some 15 percent higher than it was four years ago, and is growing at about 3.75 percent per year.

Discussion Question. If real growth of 3.75 percent proves sustainable for the next ten years, what implications does this have?

If you look at the Federal Funds rate, then interest rate have not moved since last December. However, long-term real rates have declined. This led me to wonder how much power the Fed really has over interest rates.

Federal Reserve Chairman Alan Greenspan can spin his steering wheel (the Federal Funds rate), but the correlation between those actions and the direction of interest rates in general is weak and inconsistent.

Discussion Question. What are the pros and cons for using the long-term real interest rate as an indicator of monetary policy?

Over a year ago, I wrote

The paradox of thrift is that with investment fixed, not all consumers can increase savings at once. The paradox of profits is that with consumer spending fixed, not all businesses can increase revenues at once.

Now, the New York Times has picked up on this theme.

Corporate cost-cutting and labor-saving layoffs appear in the forecasts as the golden road to greater productivity and rising profits. Never mind that we have just fired the workers and extinguished the salaries that would have been spent on the merchandise and services to fatten the profits. With sales revenue failing to rise, we cut costs more. The process feeds on itself — until there are not enough workers and salaries left to generate sales and profits.

For long-term growth and productivity, consumer saving and corporate efficiency are good things. In the short run, if demand is inadequate, saving and efficiency lead to unemployment. The best of all worlds is one in which corporations ruthlessly cut costs, consumers save much of their incomes, but aggregate demand remains high. As the Times article points out, economists count on fiscal and monetary policy to sustain aggregate demand.

Discussion Question. What does the experience of Europe tell us about economic performance when corporations do not cut costs and pursue efficiency?

In an otherwise interesting commentary about the relationship between the stock market and economic performance, The Economist makes this elementary error.

A softer dollar has already contributed to a reduction of capital flowing from Europe to America.

This type of statement is made often in the business press. Yet professional economists would argue that it gets causality exactly backwards. It is the reduction in capital flows that weakens the dollar. What has happened is that the growth in demand for U.S. financial assets finally slowed down, which reduced the capital inflow and weakened the dollar.

Discussion Question. Is the drop in the value of the dollar a bad thing?

Here is a classic case of a New York Times article that represents as truth an environmentalist ideology that would get an automatic "F" in economics.

An inescapable fact about the world's water supply is that it is finite.

Actually, the inescapable facts are that substitution and technological progress mean that the world will never run out of resources, including fresh water. Bjorn Lomborg's The Skeptical Environmentalist devotes a chapter to water, in which he debunks the claim that we are "using up" all of the available fresh water.

What is true is that water is often mis-priced. The article discusses a conflict over water between Turkey and Syria, and it implies that such conflicts are intractable. Actually, it is no more intractable than a conflict over cheeseburgers between two neighboring towns. If you let the market set the price of water, the natural actions of consumers and businesses will resolve the "intractable" conflict.

Discussion Question. Why is it more difficult to use pricing and markets to allocate water than to allocate cheeseburgers?

Brink Lindsey endorses the views of Paul Gompers, Andrew Metrick, and Jeremy Siegel that eliminating the double taxation of dividends would reduce the incentives of corporations to take on too much debt and grow too quickly.

But while financial reporting can doubtless be improved, I don't think that's the biggest problem with capital markets at present. The main problem, I believe, is unfavorable tax treatment for dividends. Because dividends are taxed twice, first as corporate income and then upon payout as shareholder income, managers have added incentive to hang on to retained earnings, with the resulting blow to accountability which that entails. And investors look more to capital gains than to dividends for return on investment, exacerbating the difficulties caused by imperfect financial reporting and stock valuation.

An even better idea would be to abolish the corporate income tax altogether.

Discussion Question. In general taxation induces substitution. When financial entities are taxed, substitution is easy, leading to a high ratio of distortions relative to revenue collected. How does this relate to the corporate income tax?

Foreign aid can be siphoned off by corruption (as Treasury Secretary Paul O'Neill's allusion to Swiss Bank Accounts implies). Alberto Alesina and Francesco Giavazzi propose a solution.

Before providing more aid or debt forgiveness two conditions need to be met. One is "institutional conditionality:" only governments that show serious progress in reducing inefficiency, robbery of public property and corruption, should receive aid.

Reasonable ways to measure corruption do exist; we know which countries are more corrupt than others. This evidence should be used more aggressively by donors to discriminate amongst receivers.

Unfortunately, in most cases the poorest countries, where aid is most needed, are also the most corrupt. So a second condition must be applied: in such cases aid flow should be kept completely out of public channels and administered by non-local groups un-associated with local elites and governments.

Discussion Question. Would corrupt governments accept aid administered this way, or would they feel to threatened by it?

Paul Krugman argues that lower interest rates are appropriate

The U.S. economy's "potential output" — what it could produce at full employment — has lately been growing at about 3.5 percent per year, thanks to the productivity surge that began in the mid-1990's. But according to the revised figures released a couple of weeks ago, actual growth has fallen short of potential for seven of the last eight quarters.

The conventional view is that we had a brief, shallow recession last year, and that recovery has begun. But the output gap tells a different story: Two years ago we went into an economic funk, and it's not over.

A recent Federal Reserve analysis of Japan's experience declares that the key mistake Japan made in the early 1990's was "not that policy makers did not predict the oncoming deflationary slump — after all, neither did most forecasters — but that they did not take out sufficient insurance against downside risks through a precautionary further loosening of monetary policy." That's Fedspeak for "if you think deflation is even a possibility, throw money at the economy now and don't worry about overdoing it."

And yet the Fed chose not to cut rates on Tuesday. Why?

Krugman makes an important point, which is that the definition of a recession as negative economic growth is too strict. The economy is underperforming any time output is below potential.

If an interest rate cut by the Fed proves to be unnecessary, it probably will be because the markets are doing the Fed's job for it. As Morgan Stanley's Richard Berner and David Greenlaw point out,

The yield on the 3% 10-year TIP [Treasury security indexed for inflation] that was auctioned a month ago has fallen sharply, by 50 basis points, or roughly the same decline as that in comparable 10-year notes.

What they are saying is that the ten-year real interest rate has fallen from about 3.5 percent to about 3.0 percent, which is nearly a 20 percent decline--during a period in which the Fed supposedly left interest rates unchanged!

Discussion Question. If Fed Chairman Greenspan believes that the interest rate that most affects the economy is the real long-term interest rate, why might he be inclined to see no need to change policy?

Dean Baker has a dire warning about a bubble in the U.S. housing market.

In the last seven years home purchase prices have risen nearly 30 percent more than the rate of inflation. This run-up in housing prices has increased housing wealth by more than $2.6 trillion compared to a situation in which home prices had just kept place with inflation. This is an average of more than $35,000 of additional wealth for each of the nation’s 73.3 million homeowners. This paper examines whether the increase in home prices can be grounded in fundamental economic factors, or whether it is simply a bubble, similar to the stock market bubble. The paper notes:

1) There has been no clear upward trend in housing costs relative to other items in the post-war period. In general, housing prices move in step with the overall rate of inflation. This means that the recent spurt in housing prices is a departure from the prior history.

Two thirds of the run-up in home prices is attributable to a rise in the price of buying a home relative to the cost of renting a home... This is what would be expected if there is a housing bubble, since it suggests that families are buying homes in large part as an investment rather than primarily as a place to live.

This led some left-wing economists (who seem to have a death wish for the U.S. economy as long as there is a Republican President) to say that this is reminiscent of Japan. It is not. Japan's real estate bubble was most notable in commercial real estate, where it was part of the Japanese house-of-cards financial system.

I should also point out that Baker's analysis is very sensitive to his starting point of seven years ago. That was a point at which rents were high relative to house prices, and some economists (including myself) were arguing that housing was undervalued, particularly relative to common stocks. If most of the increase in house prices relative to rents in the past seven years represents catch-up, then house prices are not yet in a bubble state (although particular markets may be overpriced).

Discussion Question. If home prices fall, how will that affect consumer spending?