At the International Monetary
Conference in Atlanta on June 7, 2011, Fed chairman Ben Bernanke said,
As is often the case, the ability
and willingness of households to spend will be an important determinant of
the pace at which the economy expands in coming quarters. …
Developments in the labor market will be of particular importance in setting
the course for household spending.
Seasonally adjusted nonfarm
employment increased by 232,000 in April, but only 54,000 in May — well
below market expectations for a 165,000 increase. The growth momentum of
employment fell last month. Year-on-year, 870,000 jobs were created in May as
compared to 1,274,000 million jobs in the previous month. Factory employment
fell by 5,000 last month following a gain of 24,000 in April. The
unemployment rate rose to 9.1 percent in May from 9 percent in the month
before.
But is lowering unemployment the
key to economic growth? If this really is the case, then changes in
unemployment are an important causative factor of real economic growth.
This way of thinking is based on
the view that a reduction in the number of unemployed means that more people
can now afford to boost their expenditures. As a result, economic activity
follows.
But in fact the main driver of
economic growth is an expanding pool of real savings. Fixing unemployment
without addressing the issue of real savings is not going to lift the
economy.
It is real savings that funds the
enhancement and the expansion of the infrastructure. An enhanced and expanded
infrastructure permits an expansion in the production of the final goods and
services required to maintain and promote individuals' lives and well-being.
If unemployment really were the key
driving force of economic growth, then it would make sense to eradicate
unemployment as soon as possible. For instance, policy makers could follow
the advice of John Maynard Keynes and Paul Krugman
to employ people in digging ditches, or various other government-sponsored
activities. Again, the aim is just to employ as many people as possible.
But a simple, commonsense analysis
quickly establishes that such a policy would amount to a waste of real
savings: Every activity, whether productive or nonproductive, must be funded.
So employing individuals in various useless activities simply leads to a
transfer of real savings away from wealth-generating activities, and this
undermines the real-wealth-generating process.
If the labor market were free of
tampering by the government, unemployment could be relatively easily
alleviated. In an unhampered labor market any individual that wants to work
will be able to find a job at a going wage for his particular skills.
Obviously if an individual demands a non-market-related salary and is not
prepared to move to other locations, there is no guarantee that he will find
a job. For instance, if a market wage for John the baker is $80,000 per year,
yet he insists on a salary of $500,000, obviously he is likely to be
unemployed.
Over time a free labor market makes
sure that every individual earns in accordance with his contribution to the
so-called overall "real pie." Any deviation from the value of his
true contribution sets in motion corrective competitive forces.
Ultimately, what matters for the
well-being of individuals is not employment but purchasing power in terms of
goods and services. It is not going to be of much help to individuals if what
they are earning will not allow them to support their life and well-being.
Individuals' purchasing power is conditioned by the infrastructure that they
operate in. The better the infrastructure, the more output an individual can
generate. A higher output means that a worker can now command higher wages in
terms of purchasing power.
As we have seen, the key for an
enhanced and expanded infrastructure, and thus improvements in well-being, is
an increase in the pool of real savings. But government and central-bank
policies aim at lowering unemployment through stimulus policies. This amounts to redistribution, which leads to economic
impoverishment: it undermines the living standards of most individuals.
Again, such policies do not expand the pool of real savings but rather result
in the weakening of the growth of this pool.
Fed economists hold that they can
boost economic growth by lowering interest rates and encouraging more lending
by banks. This is the point of the Fed pumping in new money through the
purchase of Treasury bonds.
But the artificial lowering of
interest rates cannot lift the supply of credit if the pool of real savings
is in trouble. Banks just fulfill the role of intermediaries: they can
facilitate the distribution of available real savings. However, they
cannot create real savings — which are the key to economic
growth. Hence, bank activities as such cannot boost real economic growth.
An artificial lowering of interest
rates cannot generate lending that is fully backed by real savings. The only
credit that commercial banks can expand is credit "out of thin
air," or inflationary credit. An increase in inflationary credit amounts
to an increase in money supply and hence to a diversion of real savings from
wealth producers to non-wealth-generating activities. Obviously then, an
expansion of credit on account of inflationary credit is bad news for
economic growth.
For Bernanke and most other
experts, the key factor that keeps the economy going is policies that allow
the lowering of interest rates. These experts hold that the lowering of the
interest-rate structure boosts consumption and business expenditures, and
that this in turn lifts economic growth through the famous Keynesian
multiplier.
Also, according to this way of
thinking, loose government spending is important for economic growth. Hence,
Bernanke holds that in curbing government outlays in the short run, one needs to be careful not to damage the economy.
A sharp fiscal consolidation
focused on the very near term could be self-defeating if it were to undercut
the still-fragile recovery.
However, Bernanke and other experts
are also of the view that if government expenditure significantly surpasses
government revenues an emerging deficit could curtail the benefits of loose
fiscal policy by pushing the interest-rate structure higher.
So what is then the solution?
According to Bernanke,
The solution to this dilemma, I
believe, lies in recognizing that our nation's fiscal problems are inherently
long-term in nature. Consequently, the appropriate response is to move
quickly to enact a credible, long-term plan for fiscal consolidation.
By taking decisions today that lead to fiscal consolidation over a longer
horizon, policymakers can avoid a sudden fiscal contraction that could put
the recovery at risk. At the same time, establishing a credible plan for
reducing future deficits now would not only enhance economic performance in
the long run, but could also yield near-term benefits by leading to lower
long-term interest rates and increased consumer and business confidence.
We suggest that the focus should
be, not the fiscal deficit as such, but curbing government outlays. Cutting
government is the best policy for normalizing the economy, and it must be
implemented as soon as possible.
Much like loose monetary policies,
loose government policies also cause the diversion of real savings away from
wealth-generating activities toward activities that do not generate wealth. Hence,
contrary to Bernanke, a severe cutback in government outlays in the very near
term will help and not damage the economy.
Obviously, various false activities
that emerged on the back of loose fiscal policies will suffer. However,
wealth generators will now have more real savings at their disposal, which
will enable them to generate more real wealth. All other things being equal,
more wealth will lead to more real savings. Failing to curb government
outlays will only weaken the process of wealth generation and will plunge the
economy into a prolonged stagnation.
What matters is to have, not strong
economic activity as such, but strong wealth-generating activities. Hence the
focus must always be on whether a given or suggested policy is good or bad
for the wealth-generating process.
Summary and Conclusion
According to most experts,
improvement in the labor market is the key for any US economic recovery. This
way of thinking is based on the view that a reduction in the number of
unemployed means an increase in the number of people who can afford to boost
their expenditures.
In reality, the main driver of
economic growth is an expanding pool of real savings. Ultimately what matters
for the well-being of individuals is not that they are employed as such but
rather that they can purchase goods and services. Purchasing power is
conditioned upon the state of real savings that fund infrastructure, which
enables individuals to maintain their lives and well-being. Policies that aim
at lowering unemployment by means of loose fiscal and monetary policies only
weaken the pool of real savings, thereby making things much worse.
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