Static equilibrium analysis is insufficient for understanding and controlling our economy. Our economy does not transition smoothly from one well-defined equilibrium to another. Rather we experience periods of dynamic disequilibrium which require more careful analysis.
Moreover, the nature of the USA economy has changed fundamentally since the nineteen eighties. Earlier the economy was occasionally subject to bouts of strong consumer demand and constrained supply that led to excessive inflation. This was countered with tighter fiscal policy and higher interest rates in monetary policy which sometimes produced recession. The challenge was to keep inflation in check while providing enough stimulus to maintain full employment. During that period the Phillips curve with its trade-off between inflation and unemployment was a useful device for understanding the policy challenge. But this relationship has fundamentally changed in recent decades.
Many authors have documented our transition to extreme income and wealth inequality. Both pay-to-play politics and advances in technology have greatly increased the return to capital relative to labor. What has been less discussed and understood is how this has contributed to a disequilibrium state where consumer demand is constrained while money has piled up in financial markets driving up stock and bond prices while depressing interest rates. Money is readily available for investment but investment opportunities are limited. Investing in an additional production line doesn’t make sense if you are unable to sell all of the product from your first production line. A combination of rapid and extensive automation and massive global supply has overwhelmed consumer demand and driven prices down or at least greatly constrained potential price increases. Inflation has fallen below and stayed below our monetary policy target of two percent.
One aspect of this situation has proven to be especially important. The very low interest rates has discouraged savings and encouraged consumer debt. Little or no savings has greatly contributed to economic instability. Consumers have taken on massive amounts of debt in the form of mortgage debt, credit card debt, home equity debt, student loan debt and, in conjunction with our aging population, medical and health related debt. In fact, in our current state of economic disequilibrium the middle class can no longer afford to buy back the value of the goods and services it is creating.
With virtually no savings, members of the middle class are operating paycheck to paycheck with no safety net. This turns income and wealth inequality into inherent economic instability. Any accident or unanticipated medical issue, not to mention job loss, could mean a sudden drop in consumption of ordinary goods and services.
To compensate for what would otherwise be a shortfall in consumer demand, the Federal government has stepped in with unpaid-for tax cuts and increased expenditures that have substantially increased the Federal debt. The proponents of new monetary theory who generally dismiss the importance of this ever increasing national debt have implicitly understood the growing and essential role of the Federal government in supplementing the otherwise inadequate consumer demand.
But it is monetary policy that is partially to blame for this situation. The practice of buying Treasury securities in the New York financial markets has greatly contributed to stock and bond price bubbles, but, more importantly, to lower interest rates and the over-indebtedness of the middle class. In this way, with the help of the mathematics of compound interest, monetary policy exacerbates income and wealth inequality by making the rich even richer (higher stock and bond prices) and the middle class poorer (deeper in debt).
Forthcoming book “Optimal Money Flow” proposes creating “My America” Federal Reserve smartphone bank accounts for everyone with a Social Security number. When the economy slows, money can be injected directly into these accounts to avoid recession. This would be much more effective in reviving the economy and require much less money than the enormous amount of money given to Wall Street bankers, which is a waste of time when consumer demand is inadequate to justify adding another line of production when companies can’t sell all they are producing with their first line of production. Instead, Wall Street bankers just buy more stocks and bonds. Giving the money directly to consumers makes much more sense.
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The author has agreed to forgo his book royalties so that the full purchase price ($24.95) will go into the student scholarship fund when purchased through Avila University Press at the link: https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh