The focus of the preceding

Economists have two roles. As scientists, they develop and test theories to explain
the world around them. As policy advisers, they use their theories to help change
the world for the better. The focus of the preceding two chapters has been scientific.
We have seen how supply and demand determine the price of a good and the
quantity of the good sold. We have also seen how various events shift supply and
demand and thereby change the equilibrium price and quantity.
This chapter offers our first look at policy. Here we analyze various types of
government policy using only the tools of supply and demand. As you will see,
the analysis yields some surprising insights. Policies often have effects that their
architects did not intend or anticipate.

God would be exalted

Observing that when the king ascended to the throne the slaves put their necks under his heel
and covered their bodies with dust, in their haste the priests
concluded that by degrading man God would be exalted. Prostrating
themselves in dirt and rags, men went down in order that by contrast
the throne of God might rise up. The mud was made thick upon man's
brow that the crown upon the brow of God might be made brilliant. Out
of this degrading thought grew the idea that God lived and ruled for
his own gratification and self-glory. The infinite throne was unveiled
as a throne of infinite self-aggrandizement. Slowly it was perceived
that the parent who makes all things move about himself as a center,
ever monopolizing the best food, the best place, the best things, at
last becomes a monster of selfishness and suffers an awful degradation,
while he who sacrifices himself for others is the true hero.

Eastern car Hire

Data from every corner of the world
show that when cities raise the price of
water by 10 percent, water use goes
down by as much as 12 percent. When
the price of agricultural water goes up
10 percent, usage goes down by 20
percent. . . .
Unfortunately, Eastern water users
do not pay realistic prices for water.
According to the American Water
Works Association, only 2 percent of
municipal water suppliers adjust prices
seasonally. . . .
Even more egregious, Eastern water
laws bar people from buying and selling
water. Just as tradable pollution permits
established under the Clean Air Act have
encouraged polluters to find efficient
ways to reduce emissions, tradable water
rights can encourage conservation and increase
supplies. It is mainly a matter of
following the lead of Western water
courts that have quantified water rights
and Western legislatures

Adequate retirement

So investors, especially those who have retired or are about
to, have no alternative. While Treasury securities are still a haven
for investors because of their low risk of loss or default, they may
not be a safe harbor for those who want an adequate retirement
income. Without adding more risk to your portfolio—even if it is
heavily invested in U.S. stocks—your investment earnings could
just be too low to live on, even if you have done a good job of
saving for retirement.Adding more than what has been considered normal or average
risk to your portfolio may become so de rigueur that Wall
Street will adjust all its risk-measuring devices to make it appear
that no more than normally needed risk is being taken, even if
many investors say they have no stomach for it. (So-called sophisticated
investors are already doing this, using hedge funds, complex
securities called derivatives, and other similar tools.)

Normally needed risk

Adding more than what has been considered normal or average
risk to your portfolio may become so de rigueur that Wall
Street will adjust all its risk-measuring devices to make it appear
that no more than normally needed risk is being taken, even if
many investors say they have no stomach for it. (So-called sophisticated
investors are already doing this, using hedge funds, complex
securities called derivatives, and other similar tools.)

Confidence improves

As our confidence improves, we should take countermeasures
to keep our feet on the ground so that we maintain our
sense of equilibrium. At the beginning of an investment campaign,
this is not as much a requirement as it is as the campaign
progresses, because fear and caution help rein in our tendency to
make rash decisions. As prices move in our favor, the solid anchor
of caution gradually disappears. This means that sharp market
movements that go against our position hit us by surprise. It is
much better to be continually running scared and looking over
our shoulder for developments that are likely to reverse the prevailing
trend. Such unexpected shocks will be far less frequent
because we will have learned to anticipate them. When events can
be anticipated, it is much easier to put them in perspective. Otherwise,
their true significance may be exaggerated. The idea is to
try to maintain a sense of mental balance so that these psychological
disruptions can be more easily deflected when they occur.

10-year note

On the Treasury’s 10-year note fell as low as 3.13 percent
in June of 2003, the lowest yield on a 10-year maturity since
July of 1958, based on Federal Reserve interest rate data.
The money managers at PIMCO, the big bond mutual fund
company where McCulley works, are predicting that the yield on
the Treasury’s 30-year bond, which was revived by the government
in 2006, could fall below 4 percent in the next three to five
years. It was at 4.81 percent at the end of 2006. How tempting is
it to tie up your money for 30 years for an annual return of 3.5
percent? You’ll just have to look elsewhere and try a new dance
step with the risk in your portfolio.

Fed policy

There is a point to this economic history. The volatility it describes car rent in
the bond market and the steps it details that Fed policy makers
had to take to counter that volatility and reach their objectives
are both arguments for an inflation target.
The forward-looking commitment to interest rates remaining
low that Fed policy makers imparted with the three words “a
considerable period” was a brave new step for policy makers, essentially
providing a forecast of its policy intentions.

Publications

Unlike most other CPS-sourced publications, the Social Security Administration uses
the concept of “aged units,” not households, families, or unrelated individuals. An
aged unit is either a married couple living together (at least one of whom is aged 55+)
or a nonmarried person aged 55+. A nonmarried person is one who is unmarried
(widowed, divorced, or never married), separated, or married but living apart from
their spouse (for example, someone whose spouse resides in a nursing home). This
aged unit definition includes the aged population whether or not they live with other
relatives. For the purposes of this chapter, the authors have further concentrated on
the elderly aged unit (those aged units where at least one person is aged 65+). This is
a broader definition than that used with many other CPS-sourced publications that
classify someone aged 65+ living with a younger relative, who is considered the house-
holder, as a “family under 65.”

Equal distribution

Consider, for instance, policies aimed at achieving a more equal distribution of
economic well-being. Some of these policies, such as the welfare system or unemployment
insurance, try to help those members of society who are most in need.
Others, such as the individual income tax, ask the financially successful to contribute
more than others to support the government. Although these policies have
the benefit of achieving greater equity, they have a cost in terms of reduced efficiency.
When the government redistributes income from the rich to the poor, it reduces
the reward for working hard; as a result, people work less and produce
fewer goods and services. In other words, when the government tries to cut the
economic pie into more equal slices, the pie gets smaller

Fed funds futures

Fed funds futures contracts can be seen on the web site of
the Chicago Board of Trade, at www.cbot.com, by clicking on
30-day fed funds. (As of the end of 2006, the CBOT was planning
to merge with the Chicago Mercantile Exchange.) What you
see on this page of the CBOT site is the fed funds futures contracts
by month and their prices. Subtracting the price from 100
gives you the approximate level of the average fed funds rate that
is predicted for that month. There is more detail on fed funds
futures and how to read them at the web site of the Federal Reserve
Bank of Cleveland, at www.clevelandfed.org/research/policy/
fedfunds/faq.cfm.