Friday, June 28, 2013

Economic forces, a sketch

Some people may say that when you make a payment on your debt, the guy who receives the money spends it; so that paying down debt is not really a drag on the economy.

But of course it is a drag on the economy. For paying down debt is the "equal and opposite" of taking out a loan. And taking out a loan typically helps boost the economy.

The opposite of taking out a loan is paying it down. And the opposite of boosting the economy is slowing it down. So of course paying down debt is a drag on the economy. It has to be.

Gene Hayward said...

A simple question for my simple mind. I like what you say in this post. Will be a good lesson for my students. But I would like clarification. Please indulge me.

Using a Fed calculator (http://www.federalreserve.gov/creditcardcalculator/Default.aspx) to calculate payments and interest on a \$2,000 credit card "loan", if I were to pay it off in 1 year my monthly payment would be \$174.00. That totals to \$2,088. Using a simple multiplier of 1, are you suggesting that the net effect after one year is a "drag" on the economy of \$88?

So, while the economy gets the original \$2,000 boost from credit, it gets drained by the principal payments each month primarily then secondarily by the \$88 interest?

I wont hold you to the math, just the concept.

Thanks you for your time and attention!

The Arthurian said...

Hi Gene. How much of the interest received comes out as payroll or investment? The rest remains "in finance" where it adds to the imbalance between money in the financial sector and money in the productive sector.

Probably somewhere between half and all of the interest remains in the financial sector (where it can earn more interest). The proportion in finance was probably very low after WWII. But because interest income to finance tends to stay in finance, and because people want to save, the proportion gradually increased for about 60 years.

I don't know how much interest, on average these days, stays in finance. I don't know how to find out. But say half of it stays in finance. Then not \$88 but \$44 never returns to the productive sector. (And it's probably more than \$44.)

Yeah, you definitely have the idea Gene.

If people don't pay off the loan in a year, the principle amount is less but the interest amount is more, and it lingers for years.

Maybe I'll do a spreadsheet on this. Thanks Gene.