William Dudley is the President and CEO of the Federal Reserve Bank of New York. He gave a speech about the economic outlook. The speech is standard talk about economic improvement that is not good enough yet. He states that demand is a constraint on the economy.
“Turning first to consumer spending, such spending has remained fairly subdued outside of interest rate-sensitive consumer durables. In July, for example, real personal consumption expenditures were flat, and it is unlikely that third quarter consumption growth will be much above a 2 percent annual rate.
“Moreover, the drivers of consumer spending do not look particularly supportive. In particular, real disposable income growth has grown at less than a 1 percent annual pace since March. Furthermore, the recent data do not yet clearly indicate a firming in the income growth rate, or the two important components of labor income growth—hours and compensation.
“The conundrum for consumers is a simple one: if consumer spending growth is to exceed 2 percent annualized on a sustained basis at a time when real disposable income growth is below 2 percent then this would require the household saving rate to decline persistently. But there is little reason to expect such a decline given that the current saving rate is at a level consistent with current level of household wealth relative to income.
“We have a chicken-egg problem. If the saving rate remains stable, then stronger consumption growth will require a pickup in income growth. But for income to rise, demand must increase. This suggests that there may need to be an impetus to growth from other sectors of the economy to generate a boost in consumer spending growth.”
Income… Income?… What is income?… In a black and white view, income can be paid to the rich (1%) or to the poor (99%). If increased demand comes from the rich spending more, the resulting income will go to the rich as wages are not increasing. If increased demand comes from the poor spending more, once again the income produced will go to the rich.
Keynes thought about this too… from chapter 21 of the General Theory…
“…the multiplier will be influenced by the way in which the new income resulting from the increased effective demand is distributed between different classes of consumers.” (source)
But we have to ask, if the poor are spending more, where did they get that money? As Mr. Dudley states, disposable income is rising less than 1% currently. Either savings rates go down or consumer debt rises. What does he say about consumer debt?
“Reflecting this improvement, credit standards are beginning to ease, which should support consumer spending on durable goods.”
Warning!!! … While incomes are not firming, credit is beginning to ease. This spells trouble. Do we really want the financial sector to rescue demand with credit?
But the savings rate is not expected to decline any further. Hmmm…. I guess there should be no wonder why inflation is so slow and stable.
Mr. Dudley, just say it… Wages have to rise. The poor (99%) must be the source of the increased demand.
What does Mr. Dudley say about inflation?
“On the inflation side of the ledger, inflation remains below the Federal Reserve’s 2 percent longer-run objective for the personal consumption expenditure (PCE) deflator. The year-over-year change in the total PCE deflator was 1.4 percent in July. This has created some concern that inflation is “too low,” raising real interest rates and making monetary policy less accommodative. I acknowledge this concern, but I believe it will abate as inflation moves gradually back up towards a 2 percent annualized rate over the next few years.
“Putting these factors together along with my forecast of a gradual pickup in real economic activity, my outlook is for inflation to drift back toward our 2 percent objective over the medium term. However, much like the case of the real growth outlook, there is significant uncertainty around this forecast.”
Does he really know what he said here? It will take a few years! for inflation to get back to 2% and even that has uncertainty…
Economics is in a dismal state.
I am fortunate to have an answer. I am from the West, but in my worst New York accent, I say, “Ey, Mr. Dudley, I got two words fors ya.” … Effective Demand.
Everything he is talking about is explained by Effective Demand, which is lower than previous years and decades due to labor receiving a substantially smaller slice of the national income pie. Low Effective demand explains low savings rates, low inflation, low demand, low income, high unemployment, low wages, mild improvement in the labor market, ineffective monetary policy, and mild but unsatisfactory economic improvement.
And to top it all off, Effective demand points to an economic slowdown in real output within the next two years.
If we had had a knowledge of effective demand in the past, we would have been able to approximate the timing of every recession since the 1960’s, except for Volcker’s. We would have been able to describe the effects on real output and inflation. And if we were to get some smart economists working in effective demand, we might more clearly see the effects on business investment and more.
Look… Here is the bottom line. Effective demand has moved to a new low normal in the past decade. Whether you think the overall economy has or not, effective demand has. According to the track record of effective demand, the potential of the economy will be cut short below the expectations of economists who are looking at past data. How can this happen? The one piece of data that has never substantially changed until now, and which economists are subsequently not prepared to understand… is effective demand.
Effective demand is going to make a sneak attack on the economy.
One last word from Keynes who never nailed down an equation for effective demand, but had insights into how it would work.
“For the schedule of liquidity-preference itself depends on how much of the new money is absorbed into the income and industrial circulations, which depends in turn on how much effective demand increases and how the increase is divided between the rise of prices, the rise of wages, and the volume of output and employment.”
Keynes’ insight here is reflected in the equation for effective demand which speaks to wages, output and employment.
Effective demand = Real GDP * effective labor share rate/(capital utilization rate * labor utilization rate)
The question is… How will the Fed get new money to the right class of consumer in order to increase effective demand at the right time to increase output and employment and maintain price stability?
Answer: In order to not fall prey to the fallacy of composition, wages must be raised across the board, and if possible, across many countries.
Capital has too much money and Labor does not have enough… Full stop.