Plugging the Inflationary Gap

The figure below represents an economy that has grown so quickly that the aggregate demand has been pushed to the right, beyond the long run aggregate supply curve. AD₁ represents the current state of the economy. It intersects with the short run aggregate supply curve at E₁. The intersection means that the overall price level has increased from what would be it is equilibrium level where the aggregate demand, the long run aggregate supply and the short run aggregate supply curve would all intersect at point E₂.

Figure 2 adapted from Krugman & Wells, p. 381

            The current equilibrium has raised the price level so that the economy is undergoing a period of inflation. To move the economy from the equilibrium from the point E₁ to E₂, the government in charge of this economy needs to undergo some contractionary fiscal policy to move the aggregate demand curve from AD₁ to AD₂, making the equilibrium point meet the line of potential output instead of outpacing it.  There are several options that this government has to enact its contractionary fiscal policy. One option is to decrease the amount of direct government purchases of goods and services. Another option is to increase taxes so that consumers have less money to spend. A second way to limit money in consumer hands would be to decrease the amount of transfers the government sends to consumers (Krugman & Wells p. 381).

            All three options would have the effect of lowering the aggregate demand so that the economy would be able to cool off and the period of inflation would dissipate, moving the aggregate demand curve to the point where the equilibrium point is on both on the short run and the long run aggregate supply curves.  

How to Grow the Economy

If the government wants to expand the economy, it could go about doing it multiple ways. It could cut taxes, so that consumers have more money in their pockets. The government can also send money to people in the form of checks as transfer payments. Both of these can be good politics as they can be spun to show that the government is trying to shrink itself and to not spend the people’s money wildly. Both of these can trouble because of the marginal propensity to spend. If people save that new money instead of going out to the store and spending it, that money is wasted in terms of trying to grow the economy. Money not spent does not show up in the GDP calculation (Krugman & Wells p. 386).

            However, there is a more effective way to grow the economy. If the government instead spends the money on good and services, the same money is out in the economy. There is still the fact that the money will get pushed on through to consumers, who will then spend only a fraction of that money and the government has to be cognizant of the marginal propensity to consume. Growing the size of the GDP directly through growing the G section of the GDP equation is much stronger than just giving people money. Not only does the government get money out into the economy, but the nation also gets a new bridge or jet fighter or whatever it is the government bought.

There are bound to be limits to this sort of growth.  For example, there is a lag time to new acquisitions. When the stimulus package was passed in the wake of the economic crisis of 2008, many of the infrastructure projects took time to get off the ground and there was much political hay made over the idea of “shovel ready projects”. Just sending checks to people is much faster, but then there are fewer jet fighters or state-of-the-art bridges. Overall, the lag time is a fair trade off as long as the MPC is below one.

Finally, there is a further concern that there are only so many bridges that can be built or improved. Once the nation is in a post-scarcity gleaming futuristic utopia then the direct government expenditure approach might not be the most effective avenue for growth, but the nation is far from that point for now.

Automatic Stabilizer

An example of an automatic stabilizer would be the issuance of unemployment insurance. When the economy is in an expansionary phase, the government has to pay fewer claims of unemployment. When the economy is contracting, then the government has to pay more unemployment claims. This is an automatic stabilizer because it helps moderate the business cycle. Money is pulled out of the system by having fewer transfers when the economy is in expansion. Conversely, recessions are not as bad because unemployment benefits are spend in the economy, boosting consumer expenditures (Krugman & Wells p. 388).

            Figure 1 below is a representation of two different economies growing on the same track. The blue line is the economy that does not have automatic stabilizers in place. Its growth is more erratic, the peak is higher, but the trough is also deeper in comparison to the peak. The economy represented by the orange line is one that has automatic stabilizers in place, like unemployment insurance. The path is moderated so that the peaks are lower, but the trough is also not as deep as the one in the blue economy.

Fig One

All This Gloom About Unemployment

This one's a little dry, comes from a current even assignmenet were we were supposed to look at two articles detailing the current economic situaton through the lens of one economic indicator. I chose unemployment. The best thing about school is that it makes you write, even if it is not something you are wholly engaged in, just the process makes you better.

For the month of October, the unemployment rate dropped to 5.8%, the lowest rate in recent memory. Unemployment had been higher than it had been in a generation, topping out at 10%. The graph below shows the progress in the unemployment rate for the last ten years, showing its increase during the recession and the slow climb down to a more natural rate of unemployment.

Figure One

The steady decline of the last few years might be a cause for celebration, but two recent articles have found that the headline number is not the end of the story. Americans still have concerns about the labor market, in spite of the good news coming from the Bureau of Labor Statistics.

The first article is “Why Many Aren’t Celebrating Low US Unemployment,” by Josh Boak, an economics writer for the Associated Press. The article was published on the ABC News website. In his article, Boak looks at the current unemployment rate and tries to unravel the disconnect between the low unemployment rate and the current sentiment about the state of the economy. He leads off his article by noting how exit polls showed that a majority of the voters surveyed said that they cast their ballots based on “fear for the economy” (Boak 2014). He further explores the fact that the low unemployment rate is not the only piece of good news for the economy lately, specifically pointing out that home sales and auto sales have increased (Boak 2014)

            The good economic news is tempered by the fact that pay is increasing, but only in line with the low inflation that has been a part of the current recovery. This lack of growth has created the perception that worker’s standard of living are declining. This perception is compounded by another metric. Boak points out that the labor force participation rate has been stagnant for the last year, and has decreased since 2008. This bad news more than balances out the good news that is available. He cites polling done after the election showing “Roughly two thirds of those surveyed described the economy as ‘getting worse’ or ‘staying about the same.’ And 78 percent declared themselves worried about the direction of the economy” (Boak 2014). The worry will continue, as Boak ends his article citing an economist saying that wages will not grow fast for a while.

            Joining the chorus in a structurally similar article, Patricia Cohen wrote in the New York Times an article titled “Jobs Data Show Steady Gains, but Stagnant Wages Temper Optimism.”  In her article, Cohen cites the same job growth data Boak looked at, where unemployment is dropping and jobs are being added to the economy. She then turns and looks at some of the other issues that are bringing down the American worker’s morale. First, she looks at wage growth, where they have increased only two percent in the last year but almost not at all in the last couple of months. She then looks at the labor force participation rate that Boak looked at, bit she focuses on a slight uptick of the rate to 62.8 percent where Boak claimed that it had not moved. This increases gives Cohen some optimism, and she looks elsewhere in the economy to corroborate it, point out the ending of the Federal Reserve’s decision to end the most recent round of quantitative easing (Cohen 2014).

            Still, in spite of the good news, Cohen identifies that Americans are not that optimistic about the economy. She looks at the fact that productivity gains have not gone to workers like they had decades ago. She also looks at the optics of highly paid chief executive officers making many multiples of workers’ salaries. She then cites the same survey Book does in looking at Americans’ optimism about the future of the economy – a solid majority is not confident (Cohen 2014).

            Cohen gets deeper in trying to understand this divide than Boak does. She looks at the quality of the new jobs that have been created and which are pushing down the unemployment rate. She finds that part of the malaise in the job situation is that so many of the new jobs are low paid jobs in the service and hospitality sectors. These jobs have little bargaining power and thus they cannot help force wages up, a move which would make people happier about the state of the economy (Cohen 2014). She also looks at the persistence of long-term unemployment and the weakness in the world economy.

            Overall, Cohen strikes a much more optimistic note about the short-run path of the economy. Where Boak ends his article looking at the possibility of persistence of low wages, Cohen ends her article on a bright note, quoting an economist saying, “It definitely looks like things are slowly moving in the right direction” (Sinclair qtd in Cohen 2014).

            Both of these articles looked at the current unemployment situation and saw that though the news has been getting better, most people are still apprehensive about the state of the economy. Things are quantitatively getting better, but the perception of stagnation and even recession persists. What neither Boak nor Cohen touches on are ways to move the perception from backward-looking gloom to forward-looking optimism.

            One way to improve the public’s perception of the economy is to shrink unemployment even more. Looking at figure one, it is still above the trough that was reached in the last expansion. The easiest way to do that is to remove whatever structural employment exists. The minimum wage and labor unions create a wage floor that keeps the labor market from clearing (Krugman & Wells p. 222). If these artificial constraints on the labor market were cleared, then the equilibrium would be able to be reached. One thing to consider in that possibility though is that the natural rate of unemployment may have grown since the last expansion due to demographic factors. With the baby boom generation leaving the labor force, even a more flexible labor market may not lower unemployment enough to compensate for the political fall-out of such a move (Krugman & Wells p. 226).

            The preferable alternative to removing labor market protections is to foster a environment of growth. By looking at what the government can do to grow the economy, the people in the heartland will feel the economy growing by seeing it on their paychecks. At a time when the people are scared about the economy is the best time to fund infrastructure, education, and research (Krugman & Wells p. 257). Taking an “All of the above” approach will help in the long and the short run. The next time those polls are taken; there can be some movement on how many are fearful of the future.

References

Boak, J. ( 2014, Nov 8). Why many aren’t celebrating low US  unemployment. ABC News. Retrieved from http://abcnews.go.com/Business/wireStory/celebrating-         low-     us-unemployment-26776012

Cohen, P. (2014, Nov 7). Jobs data shows steady gains, but             stagnant wages temper Optimism. The New York Times. Retrieved from http://www.nytimes.com/2014/11/08/business/jobs-numbers-for-october-2014-reported-by-labor-epartment.html?_r=1

Federal Reserve Economic Data. (2014). Graph: Civilian Unemployment Rate. Retrieved from http://research.stlouisfed.org/fred2/graph/?id=UNRATE,

Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers

Haiku Review: John Maynard Keynes' Essays In Persuasion

Lots of stuff about

The gold standard before you

Get to the grand kids