A tale of two incomes in the money market

Real GDP has dropped to a new level. Many economists think it will return to its previous trend before the crisis.

I made this video to explain how real GDP can drop to a new level as a result of labor share of income dropping after the crisis.

Capital income rose after the crisis, while labor income fell in relative terms. Thus the supply of money to capital rose, and the supply of money to labor fell. So, the interest rate had to fall in the capital income money market, and the interest rate had to rise in the labor income money market in order to reach equilibrium. (Remember that the money in the labor market used for real GDP is many times greater than the money in the capital market.)

However, capital income controls the bond market, so interest rates fell. The result was that either prices or real GDP had to fall in order for the labor income money market to be in equilibrium at the lower interest rate. Prices have fallen some but not nearly enough to reach equilibrium in the labor income money market.

Economists talk about a recession, because real GDP is low. And they talk about having to lower interest rates to stimulate the economy. Yet, the result of the Fed keeping interest rates low is that real GDP is forced down to keep the money market for labor income in equilibrium. Meanwhile, interest rates are low for capitalists, and we have actually seen investment much stronger than would normally be seen after a recession.

The interest rate was able to adjust in the capital income money market, which meant that real GDP had to adjust in the labor income money market.

So in a word, it is LUDICROUS that the Fed is keeping interest rates low in the face of lower labor share of income. The lower interest rate forces down real GDP and creates the appearance of a recession. The answer is to find a mechanism to transfer money into the money supply of the money market for labor income. Real GDP will then rise as a result. And eventually interest rates will be able to rise.

Without a rise in the supply of money to labor, the Fed is spinning its wheels against a real GDP that has fallen to a lower equilibrium.

The Fed’s worry is creating inflation. Once again, LUDICROUS.