In today’s New York Times, Neil Irwin argues that the economy is experiencing an “epic collapse in demand.” What, exactly, does that mean?
Let’s start with this diagram from study.com:
Let’s begin at the top and move clockwise. “Households” is really an economist’s way of saying, “people, either singly or as a family group.” Their activity accounts for about 70% of US economic growth — a percentage that has been pretty stable for a very long time. But notice where their spending goes — to firms. When I buy any good, that money is treated as income to the entity selling it, which is a business.
Now, let’s go to the bottom with firms, which hire people to do work. Businesses in turn pay wages to households, which is where households and people acquire their incomes.
Hence, there’s a circular flow to the economy, which can be summed up by the phrase, “My spending is your income. Your spending is my income”
Now let’s add some data:
The above chart shows the total number of establishment jobs in the US. Two months ago, we learned that most job gains from the longest-ever expansion had been wiped out in a single month — the worst type of shock that an economy can experience. While last month’s jobs report indicates “strong” job growth, the reality is that a massive swath of the jobs market is still gone.
And that is what creates “an epic collapse in demand.” All of those lost jobs mean people don’t have money to spend. This means that businesses will see a drop in income, which will then prevent them from expanding their production capabilities and hiring more workers. This could lead to a downward sloping cycle very quickly — as more businesses cut costs, they lay-off more workers, who then slow their spending, which leads to depressed business activity … you get the idea.
What’s the total cost of this? According to Irwin:
Last week, the Congressional Budget Office tried to put a number on the aggregate economic activity that will be lost over the next decade compared with what was projected at the start of the year. That number is $15.7 trillion, reflecting both less economic activity and deflationary forces that reduce prices.
That’s about 2/3 the size of the entire US economy.
What’s the cure? Federal Spending:
“This is the time to use the great fiscal power of the United States to do what we can to support the economy and try to get through this with as little damage to the longer-run productive capacity of the economy as possible,” Jerome Powell, the Federal Reserve chair and a longtime fiscal hawk, said at a news conference in late April.
When the president of the Federal Reserve is telling you to spend, maybe you should.