Monday, May 9, 2011

Aggregate Demand Post-Recession

Keynes, if he were alive today, would claim our recession was likely a case of weak aggregate demand. Government stimulus, such as TARP, could help boost C+I+G+NX and shift the aggregate demand curve outward, increasing prices, decreasing unemployment, and getting the economy back to 2007 levels. Well, in many respects, we have reached those levels. See this post. But looking at levels without context is misleading.

As the post shows, despite being at an absolute higher level than in 2007, we are well below trend. So, why do people, particularly suppliers, feel like the economy is picking up? To be able to note our sub-trend expansion, one would need to have a rather long-run macro view. I would venture to say people's memories are not so long. And in fact, I would also venture to say that people do not truly react to changes in levels. Growth rates are the place to look.

If this quarter, a supplier experiences an increase in his growth rate of widgets sold, compared to the same time last year, he will, in my opinion, likely envision this as an increase in demand for his goods and a "better economy." It is an increase in demand, relatively speaking. In a long-run view, had there been no recession, his growth rate would/should have been much higher. But if (and this is probably the truth), our supplier is only looking at his year-over-year, or quarter-over-quarter growth, then he will only "feel" the initial dip at the start of the recession and then subsequent rejuvenation of demand for his goods later. Not to say suppliers are narrow-minded and don't have long-run views, it's just that reinvigorated demand is much more easily viewed, empirically, than a trend line on a graph. But, then again, we are all dead in the long-run anyway.

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