Tuesday, March 28, 2017

The "New Normal" as Exclusive Territory

What's wrong with the "new normal", especially as central bankers prepare to pull back further on quantitative easing? Even though some central bankers are still easing monetary conditions, it won't be long before they reverse course, and follow the contrarian lead of the U.S. However, policy makers risk creating new problems, if they give the impression they've done all that's necessary, for economic stability.

James Pethokoukis recently posted his own concerns that the "new normal" could be here to stay, "unless we do something about it". He points out what is a most telling graph, in a recent paper from Brookings. This graph highlights not only a gradually declining labour force participation rate, but also reductions in aggregate output.

And how to think about further rounds of monetary tightening, given losses in discretionary spending which populations continue to face? More income is being allocated for basic life necessities. Without sufficient monetary representation for all concerned, there's even less room to support the productive sectors which have been responsible for centuries of progress. Given these circumstance, declining monetary representation implies less discretionary spending over time, on the part of more households in the future. Will the majority of economic activity, eventually become associated with exclusive territory? Regarding the problems of discretionary income, Arnold Kling wrote:
There is a significant portion of the population with above-medium income and close to zero saving. I think it is hard to tell a story that explains that in terms of rational behavior. Remember we are talking about a lot of people, not just a few random exceptions.
As loans continue to mature, central bankers will gradually unwind their large balance sheets. There's a good chance that debt formation will play a less significant role, in the near future. However this likelihood is more problematic than it may appear. After all, new alternatives for wealth creation which go beyond further debt formation, are not yet on the horizon. Consequently, many who still lack economic access, are less likely to change their circumstance for the better, any time soon.

Perhaps the fact that debt formation has become less associated with wealth creation, and more associated with economic access (such as student loans and home mortgages) is an apt indicator of a mature equilibrium in need of redefinition. Even though new templates for economic participation would be difficult in the heart of general equilibrium, that shouldn't stop the creation of alternative options for economic participation along the margins. Otherwise, the new normal may begin to look more and more like exclusive territory, intended mostly for the best and the brightest.

Much debt which central bankers have become so anxious to unwind, originated from those who sought economic access on society's expected terms. New terms of economic engagement need to be actively pursued and already in motion, before any new normal can be considered valid. Wealth creation needs stronger structural foundations, which requires less debt formation to begin with. Otherwise, the new normal would mostly represent a closed door, to those presently deemed unnecessary for a 21st century economy.

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