Sunday, August 30, 2009

What really killed the economy?



Was it the bursting of the real estate bubble or the credit crunch or high oil prices? All of the aforementioned have been offered as reasons for the collapse in the global economy and asset prices that started two years ago.

The real reason, however, may have been as simple as the Fed engineering money growth rates to practically zero in early 2007. Money is ike the blood of the economy and the most basic "money" is that which the Fed creates: Federal reserve notes and reserves. These represent the two biggest components of the monetary base (coins are the third). Think of an inverted pyramid, the apex being the monetary base and all other money--bank debt, private credit etc--flowing upward toward the top.

6 comments:

Warren Mosler said...

what can the fed actually do to 'engineer' money growth rates.

for me the better story is the deficit got too small to support the credit structure via income and net financial asset growth. And when the aggregate demand (and deposits as loans create deposits) created from the sub prime fraud ceased it all started coming apart.

Mike Norman said...

Fed can certainly reduce the size of the monetary base.

Ramanan said...

Mike - I would think that the Fed really doesn't have any control over the monetary base. It has to necessarily accommodate bank's demand for reserves. Banks control the Fed and the Fed controls overnight rates.

I would tend toward Warren, the deficit got too small - in fact it couldn't finance the trade deficit and the private sector was forced to finance it which left them with less savings. Trade Deficit is good but the government has to finance it if the private sector doesn't want to. So in the end, the private sector was left with less savings.

In fact, as per recent reports, it is not surprising that citizens of the US are saving more. They always wanted to but couldn't.

For me Warren's friend Wynne Godley's predictions "Seven Unsustainable processes" stands out of the rest. Randy Wray also held this view (going by his articles).

http://www.levy.org/pubs/sevenproc.pdf

googleheim said...

I remember last year asking about the government printing money excessively for the past 8 years.

However, Norman showed with a graph from somewhere - Fed or Tsy that this was not the case and that the money supply slope from 2000 to 2008 was negative.

It was a myth that had to be debunked.

Mosler is correct but must add the 30 to 1 overleveage that made this beyond fixing as it would have it was only a matter of liar loans which was only 200 billion market.

Iraq war is still not taken into context for what it cost America.

At least the RTC from the Savings & Loan era made money after assets were sold off.

Iraq has not offerred a profit as such ... nor windfall of any kind.

Mike Norman said...

Upon further reflection, I concede! Warren and Ramanan are right. What happened to the monetary base was more a sympton (of weak demand) rather than a cause. Good job guys and, thanks!! I had a momentary loss of clarity--probably too much mainstream eco bombardment!!!

googleheim said...

no, the monetary supply swells according to elastic currency theory.

and you will not hear it on Bizradio until like 10 months after it occurs.