Wednesday, March 11, 2009

Economics 101

There are two ways to look at macroeconomics, one called Keynesian (government spending to prop up the economy) and one most recently related to Milton Friedman (monetary policy as the best way to manipulate the economy). From an accounting perspective, both yield the same answer (GNP), but they diverge in how each leads to its result.

Keynesians view GNP as the equation of the sum of income (what consumers earn for consumption, C, and what they save, S) and what the government earns in taxes (T). This side equates with expenditures, what consumers spend for consumer goods (about 70 percent of the total), private investment (I) and government expenditures (G).

The formula, C+S+T=C+I+G, symbolizes the basic model — the left side is income, the right side is expenditure. In today’s economic scenario, consumer expenditure (C) and private investment (I) have slumped to depression levels. The only salvation under the Keynesian model is for G, government expenditures, to make up the difference. The gap in the last quarter was over 6 percent, a reduction in C and I expenditures.

C and I are about 80 percent of GNP. They are so large that increasing G must be so massive to bring GNP back to equilibrium. GNP should be about $15 trillion. The 6 percent reduction would require about $1 trillion in immediate increase in G, and possibly a continuation for one or two years.

Monetary theory also has a formula for national income: M, the money supply and V, the velocity of turnover. GNP equivalent to the Keynesian would be M times V.

In our current circumstance, V has been slowed because it is the banking system that controls it. The Bush administration operated from the perspective of “juicing” the banks, getting them to lend funds so the economic system would regain its foundation and money would flow from buyers to producers to workers in an endless cycle. Nothing wrong with the thinking, it just did not happen.

Now, there is another measure of GNP I will call micro/macro. National income is the sum of all quantities bought (Q) times their price (P). In order to clear markets (Q), P must be such that there is enough money (MV). If the money supply is curtailed by a slow down in V, P must fall, a deflation — something to be avoided at all costs — it is a psychological killer.

Conclusion. If you are a Keynesian, increasing G is your chosen route. The amounts would have to be so substantial as to be impossible to comprehend.

If you are a monetarist, finding a way to increase either M (printing press) or V (getting the banks to lend) is your answer. Our first attempt was to increase V (lending by banks). It was a failure. Printing money is a possibility, but very dangerous.

The long run solution is that liquidity must be restored, that government deficits cannot be maintained at the trillion-dollar level. The real need is to restore confidence in the money supply and those who run it, the banks and the Fed.

Steamboat Springs Today March 11, 2009

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