A side note: we, economists (yes, I consider myself an economist), tend to think the whole world evolves around economics. Maybe I believe this idea is more important than it actually is, but perhaps - especially if you are also wondering what this think we call economic growth actually is - you can agree with me.
Another side note: the gut feeling I have is difficult to put in words, but I'll give it a try...
Let me start with what is going on in the markets and what a very important dilemma is that we are currently facing.
On Tuesday evening, Fed chairman Bernanke said that inflation in the US is below the Fed's target. Since the Fed has the dual mandate of keeping employment at its maximum hurry, as long as it does not hurt its other mandate of price stability, the message of Ben actually implies that the Fed will engage in another round of quantitative easing (QE II) if it sees further dangers to price stability. Hence, more liquidity injections will be advanced by the Fed to prevent deflation. When and in which way the Fed will do this is another uncertainty to which it has not given an answer (not yet at least; tonight Bernanke will give another speech with the topic what the Fed can do to stimulate the economy, speeking about which courses of action are likely and what the accompanying dangers are). However, this is outside the scope of what I'm trying to describe here.
The whole idea of the Fed is that they will provide more liquidity in order to support the economy. This money is very likely to go into assets directly, and this will unavoidably lead to increases in risky asset prices. So will this support the economy? Will this produce economic growth?
There are some conditions that have to be fulfilled, should a monetary stimulus (QE) boost economic growth, and these conditions are quite stringent:
- Liquidity should flow from the banking sector to the real economy. Hence, consumers should receive this liquidity (the banks should be willing to lend, so their prospects for receiving this money back should be sufficiently positive);
- Consumers that receive additional money should be credit constraint. That is, they have to be willing to spend this money, instead of using it to pay off debts;
- The money the central bank seeks to pump into the economy should not be directed to, for example, risky assets or commodities (gold, etc.).
If this happens, money that is created by the central bank does not stay on the balance sheets of commercial banks, but is lended to consumers, who spend this extra money. Consumers would consume, and this increase in demand would be met by additional supply.
However, increased demand for any good will certainly be accompanied by price increases. Retailers must be crazy if they would sell their products for the same price as before, while consumers received "free" money. But most importantly: there is no free lunch!
So the fourth condition for monetary stimulus stimulating growth is that prices should not rise.
Now, assume that the enormous monetary stimulus of the past two years has not created money flows into equity (increasing equity prices) or into safe havens (gold, whose price has soared, and government bonds of countries considered safe, pushing their yields to historically low levels), but consumers would have received this money, would not have consumed even more than before, and supply would have risen simultaneously. Then, we would have been back at the old situation of too much debt accumulation.
It seems that in the past, we have consumed already too much. The problem is not that now there is a lack of aggregate demand, the problem is that in the past there has been excess demand, and this was financed by borrowing, not by an increase in our own production.
So in the end, what it all comes down to, is the following:
Over our lifetime, we should contribute just as much to the economy as we take out of it. We must produce just as much as we consume. In principle (and in the long run), the balance sheet of each person, over a lifetime, should be balanced: assets equal liabilities, and there is no debt nor saving surplus at the end of a person's lifetime. Unfortunately, this is not what has been happening.
So what must be true then, is that we (us, in the West) have borrowed, from foreigners, from future generations, from the world. We are not producing in value terms as much as we are consuming.
In the train yesterday, I overheard a conversation of a woman saying that actually they were working really hard at her company. She works 36 hours a week. I am sure that she is spending more in the other 132 hours of the week than what she truly produces in value terms during the 36-hour work week.
Looking at my own balance sheet, I must admit that I have taken much. My liabilities are composed of: a laptop, a netbook, DVDs, books, a TV, CDs, my phone, the Wii, a not so small student loan, shoes, clothes, etc.. On the other hand, there is just one true asset that I have been accumulating over my lifetime: human capital.
My human capital must be truly enormous if I could have bought with it all that I own. Sure, this is called investing, and I seriously hope that I will add a lot of value to the asset side of my personal balance sheet in the future .
But still: our liabilities are huge.
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