Saturday, August 1, 2009

The collapse of effective demand

Everybody knows residential investment demand has fallen off a cliff post-housing bubble, but nonresidential investment demand is off 20 percent year-over-year because it is a “derived demand,” from the demand for consumption (which I looked at here—we are way above trend share of GDP going to consumption). 

Aggregate demand  = Consumption + Investment + Government spending + (Exports – Imports)) .  The table below shows the annualized rates of decline of GDP components.  The rates of decline of private investment spending are huge.  With capacity utilization at ~67 percent and further decreases in consumption likely, investment might at best stabilize in the near term.  The jet-assisted take-off of “multiplier-accelerator interaction” (where increasing consumption with production at capacity causes a disproportionate increase in derived investment demand) is not in the cards for the foreseeable future.  Ideally, in a Keynesian world, government would step in with government sponsored investment spending.  Unfortunately, much projected deficit spending has gone or will go to nonproductive wars, banking bailouts and health care (I support government making health insurance available to all Americans).  And after a postwar period in which “Keynesian” policies have created a mountain of public and private debt, recent Treasury auctions do not suggest a tremendous willingness of foreigners to fund our huge deficits, and we can hardly fund them ourselves unless by printing money, which will further erode foreign confidence in the dollar. 

America is a rich country.  There is enough to go around, but the realignment of national priorities required goes straight against the grain of entrenched interests, who would in fact have to give something back to the country that has given them so much.  That’s not easy for anyone to do.  But if we continue on this path the collapse of effective demand will probably continue, perhaps with a pause of a couple of years due to temporarily weakly rising “animal spirits,” ending in some form of social collapse and its consequences.

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