Friday, January 22, 2016

Think bigger

Yesterday I said:

An increase in debt ... creates a "boost" for the economy because it is extra money put into the spending stream. Paying down the loan creates a "drag" for the economy because money is taken out of the spending stream.

It's putting money into the economy that creates a boost. Our method of getting boost is to rely on debt. We borrow and spend.

The trouble with that is, it's only the increase in debt that creates a boost. Once the money's in the economy for a while, it stops having a boost effect. And then nothing's left but the drag created by existing debt.

As time goes by, new debt becomes existing debt. That makes the drag created by existing debt even bigger than it was. It's not like we got something for free. Debt has payback consequences like everything else in life. You know it's true.

The way the economy works -- the standard set by policy -- is that we borrow and spend and this boosts the economy. "We" being not only government, but also consumers and businesses. We borrow and spend and boost the economy. And then, whenever we get a little too much boost and the economy starts to "overheat", they raise interest rates.

Like now: The Federal Reserve just raised interest rates.

I guess the economy was overheating again. I must have missed it.

Anyway, that is the problem. No no, not the overheating. Well yeah, they could be wrong about that too. But that's not the real problem.

The problem, really, is that the different pieces of policy don't work well together. Policymakers encourage borrowing until they start to worry about prices going up. And then they raise the price of borrowing. It happens so often and we've heard about it so many times that it seems to make sense. It doesn't make sense.

To boost the economy, policymakers encourage borrowing. To reverse that process, policymakers have to encourage the repayment of debt. That's all they'd have to do, to prevent inflation: get people paying their debts a little quicker.

We don't have to discourage borrowing. Let borrowing continue. Let economic growth continue. Just put the right kind of limit on it. When you encourage borrowing, the economy ends up with extra debt. To fix that, we need a policy that accelerates the repayment of debt.

Fight inflation by paying down debt. Two birds, one stone.

It's not a difficult concept. It's just that maybe you never thought about it. Like the policymakers.

It's time to think bigger.


Unknown said...

Are you aware of the research on credit impulse? The rate of change of credit (rather than its absolute level) correlates roughly 89% with changes in employment (of course, whether the employment drives credit or credit drives employment or a third variable drives them both is a different question) which is a striking result, I think. Steven Keen has fleshed out the implications of this the most but the original paper is by Michael Biggs from Deutsche Bank

The Arthurian said...

Hey thanks, Unk! I saw Steve Keen use the words "credit impulse" one time but I missed the definition somehow. A search for credit impulse biggs turned up this page:

I like it already. Thanks for the heads up!