Some of my (somewhat well-educated) thoughts on the fiscal cliff:
1) The fiscal cliff is NOT the point at which the government runs out of money. Somehow this has become the widespread notion of what the Fiscal Cliff is, descriptively. Remember, the issuer of a currency cannot run out of that currency. The U.S. government, as issuer of the dollar cannot run out of dollars.
2) The fiscal cliff IS the point at which spending cuts kick in and tax cuts expire so that the deficit closes. That is, (G - T) becomes smaller. Every economist understands that this will hurt the economy because it contracts overall spending in the economy. GDP = C + I + G + (X-M). So if Taxes go up, our spending (Consumption and Investment) will go down and if government spending goes down, overall GDP will drop unless somehow we miraculously become a large net exporting nation.
3) Knowing this, we still think we have to shrink the deficit. I detailed this a couple of weeks ago, so I recommend reading that piece. IF we let the fiscal cliff happen, the economy will shrink quickly. If we reach a deal, the economy will sputter and will likely fall some if not a lot--it depends on the magnitude of the deal.
4) We need a larger deficit! This can be accomplished through spending increases or tax cuts, but the only way to actually shrink the deficit is to increase GDP. The private sector is still deleveraging, the foreign sector--our trading partners--is in poor shape, and so the only institution that can help is the government. Otherwise we're in for a long, slow deleveraging period--see The Great Depression. This is needless because the government has policy tools to prevent it, and it doesn't necessarily have to mean a concentration of government power.
5) What we spend money on matters! Some spending has a higher multiplier effect or employs more workers. Much spending is extremely wasteful and so wouldn't do much to help our society or our economy. All spending will benefit some more than others. Some spending is immoral. We need to make these decisions as a society in the political arena, but note these decisions have economic effects--see my most recent post on this.
6) We have a particular duty to look out for those left behind or trampled on by the system. We can do this personally and through institutions--including Churches, non-profit organizations, local governments, and the federal government. All have advantages and disadvantages, but all are needed according to the principle of subsidiarity, which is not a limiting principle (thinking of it solely as a principle that limits the size of government), but is rather a cooperative principle (thinking of it in terms of all institutions of all sizes working together to accomplish the common good).
A Ph.D. student's perspective on Catholic Social Teaching and economics.
Tuesday, December 18, 2012
Tuesday, December 11, 2012
Demand Signals
Economics, in some sense, is the study of choices. The study of how your choices and my choices affect economic variables and economic outcomes. This is, in part, why economics cannot be completely separated from other social science disciplines concerned with human behavior, such as history, psychology, sociology, political science, and anthropology.
One advantage of capitalist economies over other modes of production is the freedom it gives to its citizens to participate in economic life--to make choices mostly free from constraints. This freedom isn't without necessary prerequisites, qualifications, or undesirable results, however.
Instead of being organized around a central planner, our economy is organized around 'demand signals'. Production decisions aren't made by the state, but by producers usually thought of as capitalists but are really more likely small business owners, CEOs, Boards of governors, etc. They obtain funds, at least initially, from banks through loans or from the public through sales of stock. In order to obtain those funds, they must have some prospects for selling their proposed product. This puts production decisions largely in the hands of bankers, who estimate the expected rate of return on the proposed investment, or stockbrokers who do the same. For the former it means getting the loan paid back, the latter a rise in the share price.
Yet both are looking at expected rate of return, a hard to gauge variable that because it is based on uncertain expectations of the future depends more on current sales or current demand. This is where our choices come in, or our demand signals.
You see, we demand with our money and the purchase of a good or service sends a signal to the producer or to the bankers making lending decisions. That signal is usually to invest more in that product or service--to increase investment, or to raise the price of that good or service to obtain more profits with which they too use to purchase goods and services to send signals to their suppliers. It is this interconnected web of demand signals using paper money (or money from bank accounts) that organizes real output in our economy.
We don't have a central organizer or planner who has to guess how much to produce, or to guess how much we want or need of any one product or service. We send signals through 'the market' and 'it' organizes production along those signals.
There are many implication or conclusions to be drawn from this.
One advantage of capitalist economies over other modes of production is the freedom it gives to its citizens to participate in economic life--to make choices mostly free from constraints. This freedom isn't without necessary prerequisites, qualifications, or undesirable results, however.
Instead of being organized around a central planner, our economy is organized around 'demand signals'. Production decisions aren't made by the state, but by producers usually thought of as capitalists but are really more likely small business owners, CEOs, Boards of governors, etc. They obtain funds, at least initially, from banks through loans or from the public through sales of stock. In order to obtain those funds, they must have some prospects for selling their proposed product. This puts production decisions largely in the hands of bankers, who estimate the expected rate of return on the proposed investment, or stockbrokers who do the same. For the former it means getting the loan paid back, the latter a rise in the share price.
Yet both are looking at expected rate of return, a hard to gauge variable that because it is based on uncertain expectations of the future depends more on current sales or current demand. This is where our choices come in, or our demand signals.
You see, we demand with our money and the purchase of a good or service sends a signal to the producer or to the bankers making lending decisions. That signal is usually to invest more in that product or service--to increase investment, or to raise the price of that good or service to obtain more profits with which they too use to purchase goods and services to send signals to their suppliers. It is this interconnected web of demand signals using paper money (or money from bank accounts) that organizes real output in our economy.
We don't have a central organizer or planner who has to guess how much to produce, or to guess how much we want or need of any one product or service. We send signals through 'the market' and 'it' organizes production along those signals.
There are many implication or conclusions to be drawn from this.
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