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Economic Outlook II

 
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arthur
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PostPosted: Sat Dec 25, 2004 1:19 pm    Post subject: Economic Outlook II Reply with quote

There are hundreds of significant forces pushing and pulling the large U.S. economy. The U.S. with less than 5% of the world's population produces over 33% of the world's goods & services. Yet, the U.S. consumes more than it produces, through trade deficits, which pull the rest of the world's economies.

The U.S. monetary tightening cycle will continue. However, monetary policy is still accommodative (to stimulate the economy) and may not reach a neutral position until late 2005 or 2006. The U.S fiscal policy easing, of the early 2000s, may also continue, because the recent tax cuts are still intact and may become permanent. The weaker U.S. dollar is also accommodative, and will continue to stay weak until the current account deficit shrinks. A weaker dollar makes exports cheaper and imports more expensive, and exchange rates will promote foreign travel to the U.S. and discourage U.S. travel abroad. Consequently, a weaker dollar is expansionary to the U.S. economy (after the J-Curve Effect). Moreover, the stock market rise creates a Wealth Effect, which makes people feel more wealthy and become more likely to spend (the housing market also created a Wealth Effect).

The U.S. also went through a severe Creative-Destruction process from 2000 to 2002, where weak firms failed or became much smaller, freeing-up resources for emerging industries. Europe and Japan had barriers, e.g. labor immobility or capital restrictions, that slowed their Creative-Destruction processes. Consequently, the European and Japanese economies were slow to change in the 1980s and 1990s.

However, the key to sustainable economic growth, which will fuel the stock market higher over the next few years, will be if a Multiplier Effect, i.e. a level of consumption beyond autonomous consumption, can gain traction in 2005. Currently, debt levels are high and the savings rate is low. So, I doubt, a virtuous cycle of employment-income-consumption will take place.

In the NeoKeynesian Consumption Function Y = C + I + G + NX (or C = Y - I - G - NX), consumption accounts for two-thirds of output. Without significant consumption growth, I (capital investment) will be muted. However, the weaker dollar will not only increase NX (net exports), but also increase domestic consumption (e.g. through greater domestic spending of foreigners, who travel to the U.S., and domestic goods will be relatively cheaper than foreign goods).

Note, more expensive imports will allow domestic firms to raise prices, since competition falls from a weaker dollar. Consequently, profits will rise, given the Production Function held constant. This may be positive in the short-run. However, longer-term, inflation and inflation expectations will have a negative impact.

Consequently, the most important key economic variables in 2005 may be: The rate of employment growth, retail sales (a proxy for consumption), personal income (where growth has been low for the existing workforce), and any related data. Inflation may not be a problem, because there are both significant positive and negative forces (e.g. a high level of productivity and the depreciation of the dollar).

Therefore, a sustained weaker dollar will spur domestic production at the expense of foreign production (i.e. a Beggar-Thy-Neighbor policy), because U.S. consumers will shift from foreign to domestic products and our major trading partners will shift more from their domestic products to U.S. products. Also, a greater number of foreigners will spend more in the U.S. and fewer Americans will spend less abroad.

A higher level of U.S. output is inflationary. However, with debt levels high and the savings rate low, domestic consumption growth may be muted, and U.S. firms may continue to keep prices low to maintain output. So, inflation may continue to remain tame.
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