Praying for Time in the Business Cycle
The business cycle is being incredibly extended with the Fed rate at the ZLB. Effective demand is increased.
But in the end, the effects of a low Fed rate cannot keep the business cycle from closing in on the effective demand limit and ending. It can slow down the process, but it cannot reverse the process.
I made his graph to show the effective demand limit with and without monetary policy.
Without monetary policy, the business cycle would be struggling as the green dashed line cuts lower into the utilization of labor and capital (TFUR).
Recent developments in monetary policy from the dropping of the 10 year Treasury maturity rate created a resurgence that allowed the TFUR to rise without effective demand biting into it. But in time, the effective demand limit will bite… and the cost of low Fed rates not disciplining the markets will be paid.
In essence, monetary policy is Praying for Time…
I think the decline in Gas prices has lengthened the business cycle
I was saying earlier that either wages would have to go up or gas prices would have to fall to keep the economy going, the former has not happened yet, but the latter seems to be in full swing.
Will the overextension cause a “harder” landing?
Wages are rising. Look at business costs. Lets remember for the 1000th Time: GOVERNMENT LAGS ON WAGES.
Of course from the pov of Joe Six Pack, wages aren’t really going up, they weren’t in 1997 as well. It takes time for wage increases to build up enough, to where Joe Six Pack sees the progress.
I included the fall in oil prices in the first version of the post, then I took it out because the effect on inflation has been mild so far compared to the effect from interest rates. But I agree, when inflation falls, effective demand will increase even more. We may see effective demand rise with the utilization of labor. Then the Fed will raise the Fed rate, but longer term rates may not follow suit. It will be interesting.
That is why some people call deflation good… but there will be costs.
The over extension that will cause a deeper recession is how far the TFUR extends above effective demand. The more it rises above it, the harder the recession. I am seeing that pattern in the new data.
Wages are rising and it has not shown up in the data yet. We have to wait another month for 4th Q numbers.
Also, consumption responds to changes in inflation too, even if wages do not change. We can expect consumption to rise with higher wages and lower inflation, but I am doubtful that businesses will share the extra profits from lower oil costs with labor. If I start to see labor share going down implying that businesses are not sharing with labor, that would make me upset.