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Net Effect

 
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arthur
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PostPosted: Sat Feb 26, 2005 7:11 am    Post subject: Net Effect Reply with quote

Economists typically isolate economic variables to find their net effects, using mathematical and empirical models. However, a successful general equilibrium model of a large economy hasn't been created. I'll present both a general, athough crude, bullish and bearish case of the U.S. economy.

Bullish Case: Monetary and fiscal policies are still accommodative. The Federal Reserve is tightening the money supply rather slowly to reach a neutral state. Consequently, monetary policy is still stimulative. The tax cuts over the past few years are still in place, which will contribute to economic growth. The weaker dollar will spur export growth, which will increase output and employment. Consequently, household incomes and the labor force participation rate will both rise. A virtuous cycle of employment-income-consumption will gain traction raising living standards, particularly for the formally unemployed. Debt will be paid down and saving will rise, which will lower risk for businesses (e.g. lenders) and make households stronger. Firms, which strengthened their balance sheets over the past few years, will ramp-up investment (e.g. in new technologies or processes) to keep productivity high and maintain strong profit growth. Even higher import commodity prices (e.g. for raw materials and oil) will keep the capital account surplus high (along with a high current account deficit) to maintain a high level of foreign investment. Also, energy use is an increasingly smaller proportion of the U.S. economy, while the U.S. moves into "lighter" industries, e.g. biotech, internet businesses, software, and processes . The S&P 500 will continue to stay above 1,160, because people will find stocks a better investment than bonds. Consequently, the stock market will "pull" the economy, and continue to generate a "Wealth Effect."

Bearish Case: The U.S. is currently in a structural bear market, similar to 1929-38 and 1973-82 (the stock market was flat from 1965-82). The U.S. had a mild recession in 2001, because of substantial easing of monetary and fiscal policies. The recession was followed by above trend growth from mid-2002 to the present time. The mild recession and strong growth were fueled, in large part, by the use of savings and accumulation of debt. Moreover, the recovery over the past four years has been a jobless recovery. Consequently, households are in a weak position to maintain above average consumption growth. Furthermore, high gas and utility prices are draining a larger proportion of income and wealth from households, while monetary policy is draining money out of the economy. The weaker dollar will continue to expand export growth, generating greater corporate investment and employment. However, domestic consumption growth (which represents two-thirds of GDP) will be muted, because debt levels will be paid down (instead of increased) and the savings rate will rise (from higher interest rates). The vast bulk of the 80 million baby-boomers, who will start to retire in a few years, are not even close to saving enough for retirement (i.e. to maintain living standards).

One of these cases will be stronger than the other.
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