Wednesday, September 28, 2011

The root of all evil is: Lack of Demand

Just about all economists agree that lack of demand is causing the economic slowdown.

The recession has done a small amount of good. It has clarified economic theory for a lot of economists that were on the fence. You don't hear to many efficent market theorist discussing how the economy will correct itself automatically these days. Now, in general, most economist area agree the problem is lack of demand. They also agree the US economy needs some stimulus.

Economic theory also tells us that you can stimulate the economy two ways. You can increase demand though monetary (interest rate and money supply changes) and fiscal (government spending) policy. Fiscal policy is either direct spending or investments or incentives (subsidies and tax policies) to encourage private spending. With interest rates effectively at zero for the next two years (monetary policy) only government spending remains(fiscal).

Let's look more closely at the three places where this lack of demand comes from. One, corporations and the rich are sitting on large piles of cash. They can no longer find investments with returns equal to historic returns. So they are sitting this one out. Second, the poor and middle class consumer is tapped out. The middle class has lost huge amounts of home equity. They nervous about their employment situation. The fear of unemployment has led consumers to cut spending in favor of paying down debts and savings. And the third source of low demand is steadily job cuts in government.

So basically, the poor and middle class, the engines of the consumer economy, have cut spending. The Obama stimulus helped for a bit, but was not enough. You can see the temporary spike on the chart below.

An obvious solution is to take the money from the people or companies who have more money than they need. They are not spending or investing. They are sitting on it. The money could be given to the government or people who do need it and will spend it.

Here is a quick graph of government employment.

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