I appreciate your intelligent response. Don't be fooled by the possibility of cogitating an explanation of things through the notion of capacity. Capacity like productivity is virtually impossible to define or measure and it isn't necessary to do so. These are a posteriori considerations which policy makers trot out during a certain phase of the cycle, although they can be used to refer to a state of economy. The purpose of markets is to handle all those details. Humans shouldn't bother and shouldn't try because they exacerbate all outcomes. Either you let markets do it, or you have a command economy. Command economies always end up like the Soviet Union: non-existent and you can never find the guys who perpetrated the whole nightmare.
The rest of the world is starting to come up to parity in labor cost with the US. Once this is fully in place the rebirth and internationalization of unions will be in full force. The alien races in the galaxy will not provide another production outlet and so the world's central banks will have to take on the ugly mob alone.
You might want to read a brief from a socialist camp which doesn't understand or care for Schumpeter:
newaus.com.au
Aussies have to justify why they have a poor economy with shots at the only thing that will get them out of their ongoing malaise. It's amazing that Australia, like Canada, once was fiercely competitive and capitalistic. Quebec looks like the Soviet Union. It has the same darkness.
I may sound perverse but when I say the FED is making money cheap I don't mean that money is sloshing around. It isn't. That never occurs! Proof: During inflation money is tight. Since inflation has never gone negative for longer than a month in the modern era, money has always been relatively tight. In deflation money is loose and idle. Though cheap and plentiful, people are usually too fearful to borrow. During the last 20 years in spite of all the hoopla inflation only slowed in its rate of growth.
There are two classes of inflation: economic and monetary. Economic inflation deals with labor and output. Monetary inflation deals with supply and demand of money. All the errors made about inflation come from an ad hoc mixing of the components of the two classes. The result is like an exponential composition of functions so that deviations from norms in either lead to unpredictable exponential amplitudes in the result. The price of gold persistently rises when the two reinforce each other, because outcomes uncertainty rises non-linearly with linear changes in the component factors.
For example, right now the FED is fixing the price of money at a rate which doesn't accomplish its intended effect on economy. The FED is using a monetary deflation to slow an economic inflation. The economic inflation is evidenced by rising ECI and falling productivity, so more compensation is demanded for less output. The market would raise rates by slowing the availability of money, so that monetary demand would have to slow because the money borrowed couldn't expect to realize an economic return commensurate to its cost. The FED is not doing this. They are not slowing the availability of money because they are holding down its cost by supplying more than is needed at the margin. The evidence is seen daily when fed funds rise above target so FED comes in and supplies reserves. Since the extra supply is at the margin there is little monetary inflation as a result, but at the same time economic inflation is not impacted. The FED waits so many months to see the degree of their last rate increase and then acts, but the economy transforms so that the same activity is now done at a higher effective interest rate. Raising rates is fine, but effectively lowering them in the interim necessitates that the next move is always up.
Economy adapts to every incrementally higher rate, but can only do so by raising prices, since all the economies of scale and potential efficiencies are squeezed out during the early phases of the monetary price fixing regime in the cycle. This isn't to say that raising rates causes inflation, but it is to say that supporting economic inflation by mistakenly preventing monetary deflation does cause general price inflation.
The persistent general price inflation comes when interest rates are structurally high, say, 6%, which cools general activity but doesn't impact necessary goods and services. The FED then panics and pumps in lots of money to revive the inefficient or for other reasons like bank run and political expediency. The rates briefly fall and activity revives, but the new initialization basis is 200 pints above the previous trough. This combination re-ignites economic inflation which only slowed somewhat and adds monetary inflation because how the extra money is used changes. People start buying to beat rising prices which you mentioned in your previous remarks. The buying misallocates the money resource and creates extra demand for low output investments like hedges. Rising general prices force economy factors like labor to demand for higher wages for protection from inflation. The result is both monetary and economic inflation. At that point the FED can only stay out of the market and let the market do the necessary dirty work: bust inflation psychology with Draconian interest rates. None of this would have occurred if FED always stayed out of the market and created money on a supply basis only.
The supply target could be set at anyone's guess of productivity. The market would not be moved by failure of the FED to miss the supply target. The FED is relieved of doing something that can't be done and society is relieved of the wild swings. Gold would never change in price and inflation would always be zero. FED did this briefly between '88 and '93 which I believe created a solid basis upon which the economic success of the '90s is built. |
