Good evening. I am delighted to join you here in Richmond to participate
in the Virginia Council on Economic Education's annual meeting. I have
been involved in economic education for a long time now, both in Minnesota
and at the national level, and I think the effort has, if anything,
become increasingly urgent. In this vein, I am pleased that the Federal
Reserve Bank of Richmond is hosting this event and that Kemper Baker
of the Richmond Fed is the chairman-elect of your organization, and
I am equally pleased to be able to publicly thank Buford Scott for his
many significant contributions to economic education. As you may know,
Buford and I serve together on the Board of the National Council on
This is the fourth opportunity I've had in the past year to address an
annual meeting of a state council on economic education. While I genuinely
welcome these opportunities, they present a challenge in that I do not
want to take these occasions to simply repeat “the same old song.”
But that means I am obligated to reflect upon and to refine the content
and the message I plan to deliver.
For this evening, I thought I would argue for the value of economic education
by demonstrating that economics can provide insight into several interesting
and somewhat controversial public policy issues. In particular, I will
provide examples of economic analysis as it pertains to four such issues:
transportation and congestion, affordable housing, the minimum wage and
deposit insurance. In at least some cases, the rigor of economic analysis
is missing from much of the public discussion of these issues, and hence
the quality of the debate has suffered. At the same time, I readily acknowledge
that considerations other than those of economics are relevant to the
policy choices that might be made. Further, let me emphasize that the
points made are not original; rather, they are part of the ongoing economic
commentary on these topics. And let me also remind you that I am speaking
only for myself, and not the Federal Reserve, on these issues.
The launching pad for these thoughts is a comment by Bob Solow, a Nobel
Prize winner in economics and a professor emeritus at the Massachusetts
Institute of Technology, in an interview
in the September issue of our Region magazine. Paraphrasing, Solow
said that conveying economic ideas clearly is a very difficult thing to
do, and yet it is essential that we succeed because too much of what passes
for debate on policies is nearly incoherent. Certainly, citizens better
steeped in the principles of economics would be able to both understand
and to contribute to discussion about policy at a higher level, and consequently
we should expect better policies over time as a result.
As indicated, I am going to discuss several issues for illustrative purposes,
and since there is no one obvious place to begin, let me arbitrarily start
with transportation. An issue in many large cities today is congestion—specifically,
a level of automobile traffic that has lengthened commuting times and
heightened inconvenience for many. One response to this problem, implemented
in numerous locations, has been special lanes for high occupancy vehicles
(HOV), that is, cars with two or more travelers. Unfortunately, such lanes
are generally underutilized and have done little to relieve congestion.
Observing this, economists have proposed opening HOV lanes to anyone
willing to pay for them, presumably drivers who want to save time and
have the financial resources to permit them to do so. By the way, the
lanes could remain free to cars with at least two travelers. This proposal,
to permit cars with only one occupant to use HOV lanes for a fee, has
been opposed because allegedly it favors those with high income and therefore
is unfair. In light of this opposition, few politicians have been willing
to take up the cause.
The problem with this argument is that it overlooks the fact that almost
everyone would be made better off by charging for HOV lanes and opening
them to more vehicles. By definition, those who pay to use the lanes are
better off because they have voluntarily decided to do so. And those who
continue to travel the regular lanes are also better off because congestion
will have decreased, since some travelers have transferred to the HOV
Taking these considerations one step further, those with training in
economics might see in pricing a potentially effective way to address
congestion more broadly. Suppose “rush hour” in city x is from
7:30 to 9 in the morning and from 4:30 to 6 in the evening. Why not charge
one price for use of highways during those hours and a lower or no fee
during off-hours? Since we, the economically literate, know that incentives
matter, we can say with confidence that such a fee schedule, known as
congestion pricing in the trade, will alter traffic patterns and will
Let me move to a second issue where an economic perspective helps to
elucidate policy options. We hear a lot today about affordable housing
and, specifically, about an affordable housing crisis. Yet, the nature
of this crisis is hard to pin down since, as far as we can tell from available
evidence, housing markets work well in most locations, and only a small
part of the population lives in substandard housing. It turns out that
the affordable housing crisis is best described as a situation where low-income
families have to spend a disproportionately high share of their income
on housing, leaving limited resources for food, clothing, medical care
and so forth.
From this perspective, the issue is more appropriately understood as
an income problem rather than a housing problem. Moreover, this is a distinction
with a difference, for it suggests that the solution lies not with
housing policies per se but with policies which increase family income.
In the long run, these may well involve an emphasis on education and training.
But in the short run, for low-income families spending a high percentage
of income on housing, one could consider a housing voucher program, a
voucher program for other necessities thereby making them more affordable
or direct income transfers to families who qualify. These are all potentially
effective means of relieving pressure on the budgets of low-income families.
All of these suggestions will have side effects to be sure, not all of
which will be desirable, but none of these proposals involves direct government
intervention in housing markets, markets that are already functioning
Also on the income front, we have the issue of the minimum wage. Proposals
to increase the minimum wage abound, and they are usually “sold”
as beneficial to people with low incomes. But economic analysis suggests
that this is not the whole story. It is more accurate to say that an increase
in the minimum wage is helpful to low-income workers who remain employed;
however, an increase in the minimum wage will decrease employment, other
things equal, because labor will have become more expensive, and hence
employers will use less.
Straightforward supply and demand analysis produces this conclusion.
But the incentive effects of an increase in the minimum wage also ought
to raise concern. An increase in the minimum wage may induce some to drop
out of high school earlier than otherwise to seek employment, since returns
to work have gone up. This outcome may not be desirable. After all, we
know that the economic and other returns to education are substantial,
and in general education is something we want to encourage. An increase
in the minimum wage seemingly does not contribute to this objective.
Finally, in a different arena, let me offer a few thoughts about deposit insurance, a policy successful in several respects but one which carries
substantial, albeit subtle, costs as well. As initially conceived back
in the 1930s, deposit insurance at banks and similar institutions was
designed to protect the assets of small and presumably unsophisticated
account holders. With the current insurance limit of $100,000 per account,
one might argue that the original intent has been surpassed, but that
is not the key point. Any amount of deposit insurance necessarily creates
a group of depositors with no incentive to monitor the quality of their
bank and worry about the soundness of its practices. This is because such
depositors know they will be fully protected by insurance in the event
the bank fails.
This absence of incentive to worry about the riskiness of the bank means
that market discipline of insured institutions is not all that it could
and should be. One might think that this is a relatively minor issue,
since large uninsured depositors have ample incentive to monitor banks.
In many cases this is true, but it is not accurate for banks deemed “too-big-to-fail,”
that is, banks so large and important that policymakers will not permit
them to fail. Even uninsured depositors may have little incentive to monitor
these banks because they expect to be protected by extraordinary government
action if the bank encounters serious difficulty.
As suggested earlier, one significant consequence of deposit insurance
and too-big-to-fail is that market discipline of banks is unduly low.
As a result, at least some banks will take excessive risks, not because
they intentionally make bad loans but because the market is not pricing
risk accurately. That is, because of deposit insurance and too-big-to-fail
policies, risk taking is priced too low, and we know from economics that,
therefore, too much risk will be taken. Even if no bank fails, mispricing
risk and excessive risk taking mean that resource allocation in the economy
is suboptimal and living standards are not as high as they could be. Admittedly,
we don't know the size of the resource misallocation, although it could
be sizable. Costs of implicit too-big-to-fail guarantees clearly have
been substantial in several developing economies where turmoil in the
financial sector and subsequent disruptions in economic activity reduced
living standards appreciably.
To be sure, deposit insurance has conferred significant benefits as well
as costs. But the point is to recognize that this policy, like so many
others, is a double-edged sword. Moreover, it is especially important
to recognize this in light of the current debate about the desirability
of increasing deposit insurance coverage in the United States, a step
I think ill-advised.
The point of these examples, as suggested earlier, is to demonstrate
that economic thinking can contribute meaningfully to significant policy
issues. Economic considerations will not necessarily be decisive but,
given the “law of unintended consequences,” I would maintain
that such considerations deserve considerable weight. After all, it is
important that we get public policy right—it can affect the well
being of many.
I suspect that emphasizing the value of economic reasoning before a group
of economic educators is tantamount to “carrying coal to Newcastle.”
That's OK from my perspective. It doesn't hurt to remind ourselves and
others that economics has a lot to say about important issues. It's one
of the reasons we should and do care about economic education—and
it's one reason why I congratulate and sincerely thank the classroom teachers,
economic educators, and business and community leaders here tonight who
have contributed so meaningfully to the cause of economic education.