There are several components to effective demand. Begin with incomes, and you quickly find the interface between demand and supply arguments: Jobs.
Jobs are -- for the individual worker and from the macro perspective as well -- a source of incomes and hence demand. Jobs are for the corporation a cost, a factor of production. A company does not produce jobs, it produces products with jobs, with labor. What produces jobs and profits is demand for those products.
Other elements of demand derive, like jobs, from income. Profits, interest payments, rents, social insurance and pension benefits are types of income. All of these are important. Stable incomes mean stable economies. But the most significant source of demand by far for forecasting purposes, second only in importance to wages and salary income, is the change in debt -- the increase or decrease in credit outstanding. The change in effective demand can be usefully understood as the change in incomes plus the change in debt.
The change in debt has been studied by economist Steve keen, following from Hyman Minsky and John Maynard Keynes. Keen has developed the "credit accelerator," the change in the change in debt, and shown its direct effect on metrics like employment. Minsky explored extensively the debt cycle, its progression through different financing structures -- hedge, speculative and Ponzi. (What we might call "investment financing," "rollover financing," and well, "Ponzi financing.")
A recent paper from Claudio Borio of the Bank for International Settlements (BIS) entitled, "The Financial Cycle and Macroeconomics: What Have We Learnt?" goes into the credit creation and destruction cycle in depth, and promises to bring Minsky's thought into the mainstream. (Although it may come without attribution; the paper owes a great deal to Minsky and Keen, but they were never cited in it." Below our predictions in this post is a sequence of observations from Borio's paper.
[Others, of course, have seen the financial cycle, the boom and bust. Notable among these is George Soros and his "super-bubble" analysis.]
In this mix is the central bank. In the U.S. it is the Federal Reserve. The Fed's activities to control inflation, its imperfect understanding of how money is created, and its capture by narrow banking interests, have combined with its power to support and affect financial markets and institutions. This combination has resulted in policies that arguably lengthen and exacerbate the contraction phase of the current financial cycle, Borio intimates. In Europe, the European Central Bank has done worse, demanding austerity as well from the nation-states it serves.
Effective demand, including incomes and credit growth, has another major player: Government. The government hires people, borrows money and produces goods and services. The public goods it produces have particular attributes that make them essential to the private economy as well as to its citizens.
Different types of income and spending affect the economy differently at different times. For example, the tax cuts of 2008 and 2009 had a very small net effect on demand, since they were used by households largely to pay down debt or they were saved. In more certain times they might have been spent. A contrasting example, the direct spending on infrastructure under the 2009 Recovery and Redevelopment Act had a very large effect, as the jobs created there supported households and a full spectrum of consumer activity. This is an area best informed by multiplier analysis, which we take up in a subsequent forecast.
With this brief background, our forecast is informed by the following predictions:
The financial cycle will continue in its contractionary phase for several years, at least. We are not near an inflection point.
The Fed and other central banks will continue to forestall debt writedown, lengthening the contraction and delaying the recovery.
Incomes from wages and salaries, rents and investments, will stagnate and trend lower.
Government hiring and investment will be in austerity mode, as its borrowing will be devoted entirely to pass-throughs to private citizens via social insurance or tax cuts. This pass-through of federal borrowing to the private consumer sector is the equivalent of the Fed's life-support programs for the banks. It enables the term "recovery" without producing one.
Sectors which can devise credit for their customers (e.g., Autos in the U.S.) will experience sales and growth. Those which cannot (e.g., certain parts of residential housing) will not.
Household balance sheets will improve only slowly, and renewed use of credit will be dampened.
Relief in the form of government hiring and investment in needed public goods is not likely in the near future.
Excerpts from
BIS Working Paper No. 395
"The financial cycle and macroeconomics: What have we learnt?"
Claudio Borio
December 2012
"The financial cycle has a much lower frequency than the traditional business cycle." p.3.
"Combining credit and property prices appears to be the most parsimonious way to capture the core features of the link between the financial cycle, the business cycle and the financial crisis. Analytically, this is the smallest set of variables needed to replicate adequately the mutually reinforcing interaction between financing constraints (credit) and perceptions of value and risks (property prices)." p.3.
"Peaks in the financial cycle are closely associated with systemic banking crises." p.4.
"The close association of the financial cycle with financial crises helps explain another empirical regularity: recessions that coincide with the contraction phase of the financial cycle are especially severe." p.4.
"The most promising leading indicators of financial crises are based on simultaneous positive deviations (or "gaps") of the ratio of (private sector) credit-to-GDP and asset prices, especially property prices, from historic norms." p.5.
"Financial liberalization weakens financing constraints, supporting the full self-reinforcing interplay between perceptions of value and risk, risk attitudes and funding conditions. A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply side developments, such as those associated with the globalization of the real side of the economy, provide plenty of fuel for financial booms: They raise growth potential and hence the scope for credit and asset price booms, while at the same time putting downward pressure on inflation, thereby constraining the room for monetary policy tightening." p.6.
"Arguably, since shocks can be regarded as a measure of our ignorance, rather than of our understanding, this approach [real business cycle analysis] leaves much of the behavior of the economy unexplained." p.8.
During the financial boom, credit plays a facilitating role, as the weakening of financing constraints allows expenditures to take place and assets to be purchased. This in turn leads to misallocation of resources, notably capital but also labor, typically masked by the veneer of a seemingly robust economy." p.8.
to be completed
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