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Understanding this economy: My View

As I recall from my macroeconomics classes, the business cycle is defined as an upswing followed by a downswing.  At the peak of the upswing the economic problem is inflation due to a hot economy.  The endogenous factor is full employment and I forget what money supply does. But for now the money supply is not in play.

At the low peak of the business cycle the economic problem is recession and endogenously the problem is unemployment.  This economic pattern is not foreign except that a longer than usual expansion has allowed us to be SPOILED.  That is, as Americans weíve done it again.

Done what, Ed

Weíve allowed a special cause (longer than usual upswing) to become the system Ė in our minds.  That is, party hardy, as if the business cycle and all that economic theory was just academic foolishness.

The foolishness said when aggregate demand was greater than aggregate supply i.e., beyond equilibrium, you worked overtime.  Overtime was to meet peak periods of demand.  However, if overtime has become the NORM, then what

The prudent manager would say eliminate waste.  The need to work overtime before demand is sufficiently beyond equilibrium is evidence of inefficiencies that should be rooted out.   BUT, if one were to throw theory out the window and presume the good times will last forever i.e., the pie has gotten bigger when it hasnít, that manager would build more capacity.  OOPS


When do you build capacity

Simply put, excess capacity is waste built due to either inattention to the business cycle or attention to projections that did not materialize.  More capacity is built when the pie has gotten bigger or your share of the pie has gotten bigger.  The old precursor to watch was GNP.  When Gross National Product increased an increase in real output was deemed to be warranted.  Did GNP increase in 1998, 1999 or 2000



Until recently, the United States used Gross National Product as its main measure of national output, while the other industrialized countries mostly used Gross Domestic Product. Since 1992, however, the United States has adopted the standards of the other countries, and now treats GDP as the main measure.

Since by definition, Gross Domestic Product is the market value of production for final use, and there are just four categories of final use, we can say that GDP is the sum of the four components:

GDP = C + I + G + NX

C = Consumption Expenditure
I = Investment Expenditure
G = Government Purchases of Goods and Services
NX = Net Export Expenditures

Here is a diagram that shows how GDP and consumption, investment, net exports and government purchases have changed over the last 35 years:


Gross domestic product (GDP) is one of the most widely used indicators of economic prosperity, and it includes the total output of goods and services for final use produced by labor and capital located in the United States. Net domestic product (NDP) adjusts GDP for the consumption of capital goods and infrastructure, but neither measure accounts for changes in stocks of natural resources or in the aesthetic value of the environment. While it may be conceptually preferable in the context of sustainable development to use NDP as an indicator of economic prosperity, the movement of the two series is virtually identical. Either indicator shows that aggregate domestic output has more than doubled since 1970, after adjusting for inflation.1 At the same time, it is important to note that these traditional measures of economic output do not adequately represent related environmental and societal variables that are important to sustainable development. Some economic transactions included in GDP may reflect environmental and social costs (e.g., costs associated with protection against crime or with recovery efforts following natural disasters), rather than contributions to the Nationís overall prosperity.


1 This series is adjusted for inflation using chained 1992 dollars.


So what

 My two cents

 The so what is this:  Whether you use gross or net, recessions occur during times of real GDP growth.  Why

because the business cycle is inelastic to GNP, GDP and believe it or not to interest rates.  In the long run, the economy, absent government tampering, is driven by consumer and investor confidence.  It just so happens, I believe, the business cycle is also dependent on consumer and investor confidence.  As consumers and investors spend, their expenditures drive real demand.  Aggregate demand follows real demand and aggregate supply trails - to complement aggregate demand.  ALL components of this economic stability is inelastic to moral suasion.


A Republican Administration in the Mix

In general Republican Administrations do not use government expenditures to influence the economy.  Rather, they use taxation in the form of tax relief.  What does tax relief do to the drivers: consumer and investor spending?  In the aggregate, not much.  The mass spenders do not net enough from the tax relief to substantially influence the flow of money.  The top 5% of those benefiting from such relief tend to invest that relief and thus do not affect GDP.  

In my opinion, taxation used as fiscal policy has no effect on the business cycle.  Thatís just politics.


More to come..