Friday, April 10, 2009

How Unemployment Stops Deleveraging

Equity Markets have bounced into spring, and Barak Obama sees "glimmers of hope" in the economy. News follows prices, so we shall see where prices end up in the coming months, but the economy seems to be falling more slowly.

Unemployment figures show why this is:

In the US, aggregate demand (the sum of Government spending, private spending on consumption and investment, and the current account surplus) has been falling, primarily because the private sector has stopped taking on more debt and is paying down the debt it already has. It has had to do this because it had burdened itself with more debt than it could support out of income, and asset appreciation has to end eventually.

When one sector delevers, another sector has to lever up in order to support aggregate demand. As consumers stopped spending, business stopped booking income, which lead to falling profits, increased unemployment, lower spending, etc. etc. This is Keynes' "paradox of thrift". The Government can step in and lever up to counteract this delevering, but Obama, not wanting to let this crises go to waste, picked slow Government spending increases over fast tax cuts to increase the deficit. The federal deficit funds private savings, the Government needs to spend in order to give us the money we need to pay taxes and net save. If Obama had reduced the fiscal drag the Government imposes on the private sector, by suspending the payroll tax, we would have seen aggregate demand remain up, banks remain healthy, etc. etc.

Thankfully, there are automatic stabilizers in the economy that work through employment. When someone because unemployed, they start eating through their savings, stop paying taxes, and draw on Government unemployment benefits. All of these "automatic stabilizers" reduce private sector savings, and increase the Federal deficit, thus supporting aggregate demand. It's doing things the ugly way, but when the administration picked a slow fiscal stimulus instead of a payroll tax holiday, unemployment was the only thing left to drive up the deficit in the short term.

So, unemployment is good for the economy so long as it drives up the federal deficit, and the economy is faltering through increasing private sector savings reducing aggregate demand. There are much easier ways to get to this nominal result so it's hard to say too much good about it, though.


Post a Comment

Subscribe to Post Comments [Atom]

Links to this post:

Create a Link

<< Home