New Effective Demand data in the Aggregate Supply - Effective Demand model

With the new equation for Effective Demand, I want to go back and pull out the Aggregate Supply - Effective Demand model from past posts. To see those posts, you can click on the link at the right under Categories.

Here is what the model looks like from 4thQ-2012 to 4thQ-2014.

The interesting thing is that the effective demand limit curves kept pointing to the same place since 2012... see circle around $16300 billions in real GDP (2009 dollars). Those ED limit lines show more consistency than before.

The last two lines of 2014 (purple and black) starting moving away from the circle destination. 3rdQ-2014 is the purple line just starting to rise away from the others. 4thQ-2014 is the black line which jumped to a higher level. So, just as real GDP was hitting the $16300 level in the second half of 2014, which would have constrained the economy, effective demand found a way to jump to a higher level. The main causes were easing of monetary policy, lower long-term rates and falling headline inflation.

Is effective demand shifting to a new level? I will be watching the new data as it comes in...

Comments

[JimH]

I located this chart for 1Qtr 2007 to 4Qtr 2008 from 5/10/2013:
http://effectivedemand.typepad.com/.a/6a017d42232dda970c01910201bcea970c-pi

On that chart if I mark the intersections of AS and ED the resulting trend is down & right, until the 4Qtr 2007 when it is up and right, and then in 1Qtr 2008 it is up and to the left.

Taken that way there is a certain similarity between the two charts. Your chart above does not turn up as much but the trend is obvious. Looking at the last two quarters of 2014, it would appear that we are seeing a less dramatic change in the trend. Perhaps the end of borrowing made the trend more dramatic in 2007.

I don't understand why ED is rising after the recession starts in the 1Qtr 2008. Is this the place where you say that we are seeing increasing capital spending in an attempt to raise profits?

And the CPI rates on the y axis on this chart do not seem to be related to my reality. Same for the chart above.

Interesting.

[Edward Lambert]

Jim,
You are seeing correctly. The crossing point between AS and Ed trends down to the right toward the natural limit of GDP.
When the natural limit is hit, the economy can take a few paths... For example,
1. Utilization of labor and capital will slow down and inflation will appear and effective demand rises. Then we see the crossing point move up. Like we saw in the 70's.
2. Utilization of labor and capital will not slow down, inflation will not change, but then effective demand will have to increase. Like we see now.

But why does effective demand rise so much at the onset of a recession? Utilization of labor and capital fall dramatically, but GDP does not. So a big gap opens up in the relationship between utilization of labor and capital and what is produced. All of a sudden, much less labor and capital is producing the same GDP. It is a warp in the data that settles out as the months go by.

[JimH]

Edward,

You wrote: "Utilization of labor and capital fall dramatically, but GDP does not. "

In the past this explanation has caused me some problems. I couldn't see the action in the real economy.

But producers could reduce utilization of labor and capital by merely slowing production and selling down inventory. Initially this change would be small and could get lost in the statistics. So the 'cause and effect' would be masked.

But even a small reduction of labor and capital by itself would immediately be a negative bias on the economy.

[Edward Lambert]

Jim,
And then we look at the end of the 1990's. Real GDP kept growing but the Utilization of labor and capital stayed within a set range.
Productivity was increasing. Labor and capital was producing more. Effective demand inflated upward allowing real GDP to rise.
At the onset of a recession, capacity utilization can collapse, and unemployment soar, but real GDP stays the same. And it is not solely due to running down inventories. There is a process of bursting a constraint on productivity. It is a time when productivity surges, and then settles into a new level.

[JimH]

Edward,

You wrote: "And it is not solely due to running down inventories. There is a process of bursting a constraint on productivity."

Certainly, if you lay off several employees, the other employees fear the same. There are less smoking and restroom breaks, and more attention to details that makes the operation run a little smoother.

There is a less cynical explanation. About 20 years ago I read about an efficiency study conducted in the 1920s, I think. Anyway, an expert recommended more lighting on the factory floor and the management agree. Months later the productivity data indicated a gain that coincided with the increased lighting. Sometime later after the expert was long gone, it was noted that productivity had slowed a little. The management decided to try to increase productivity on their own. They put more lighting in for the factory floor and presto productivity improved again but after a certain period the productivity sagged again. But now the factory floor was intensively lighted and it made no sense to add more. After thinking it over they decided to reduce the lighting a little. Presto, productivity improved. The conclusion was that when management took a more active interest in production, so did the employees.

I did a quick google search thinking that I might find a link to that original study. This is a hoot! Check out this link:
http://michiganross.umich.edu/rtia-articles/light-and-heat-can-energy-saving-technology-also-boost-productivity

[Edward Lambert]

Interesting article Jim,

[JimH]

Edward,

This is an interesting read. Don't be fooled by the headline.

http://www.washingtonpost.com/blogs/wonkblog/wp/2015/03/03/robots-are-hurting-middle-class-workers-and-education-wont-solve-the-problem-larry-summers-says/

Best Larry Summers quote: "But to suggest that improving education is the solution to inequality is, I think, an evasion."

That seems to me to be an indication that he is really thinking about the problem, not just throwing out the old stock answers.

[Edward Lambert]

Jim,
I agree with you. More education is not the answer to inequality. Labor has less power, technology is more capable every day and firms have ways to control labor costs.