Why Economic Bubbles are Good for GDP

Economic bubbles are considered bad because they run up asset values without an underlying rise in production or real value. Bubbles have occurred several times in recent history, the tech bubble of the 1990s, and the housing bubble of the 2000s being two examples. Since bubbles are artificially inspired by market sentiment, and/or monetary policy they naturally burst to become more realistically priced. These bursts have tended to be dramatic and cause substantial financial stress to unprepared individuals and entities. 

Despite the negative effects of bubbles they are also economic opportunities. Bubbles attract investment capital from foreign countries, create wealth and fuel investments spawned by the increase in asset values. Without bubbles, financial and economic stasis would be more likely, and although that is more stable, it is can also have less near-term economic benefit. For example, consider an economy without asset inflation, and with GDP growth that remains steady at 1-2%, and that occasionally rises above inflation. Such an economy only keeps up with population growth and does necessarily increase or decrease in size.

A bubble economy however, may grow 3-5% for several years straight. Moreover, according to Department of Commerce GDP data, U.S. GDP grew an average of 3.82% each year between 1992-2000. That is year over year data as well meaning 3.82% compounded over the previous year's growth. Although in the 1990s the bubble was actually based in real technological innovation, a reasonable interest rate environment existed and inflation was actually kept in check by tightening the creation of U.S. currency per the CATO Institute. This bubble was conceivably caused by over-exuberant investors rather than loose monetary policy.

Even after the tech bubble had burst annual GDP did not decline below 1%, a relatively small price to pay for a bubble that created a lot of jobs, attracted a lot of foreign capital, and generated a lot of revenue. The housing bubble was not as healthy and was fueled by inaccurate derivatives valuations, loose lending policies, and a surge of speculative real estate purchases and construction.  Interest rates were also much lower in the mid-2000s than the 1990s. Yet this led to a four year average GDP growth of 2.95%, low unemployment and large corporate, foreign and individual investments. Without this bubble, economic growth may have only averaged 1-2%, and a recession still might have occurred afterward.

The growth created by asset bubbles serves as a stimulus for economic expansion, and expansion that may otherwise be impossible to attain with more practical, but stable economic policies. As with large companies, developed countries with large economies like the U.S. have to grow GDP in the hundreds of billions to expand at a rate that can support and substantiate significant capital investment into industrial research, business development, and government sponsored programs. The need for economic bubbles suggests it is quite possible the U.S. has reached its economic apex where continued economic expansion at a consistent rate higher than 1% is difficult, unsustainable and unfounded.

Market, economic and financial commentary for the business week ending 10/14/2011

Stocks rallied for a second week erasing losses. The Dow Jones Industrial Average (^DJI) has almost risen 1000 points or approximately 9.4 percent from its 10/3/2011 low. The reason(s)? Some of the statistical economic data such as September retail sales has been positive and Euro-zone sovereign nations have collectively voted to increase their European Financial Stability Facility (EFSF) to  €440 billion or $610.89 billion to help keep banking solvency and national debt under control. 

There are also short-term trading aspects to the market that can either be ignored or not depending on if one is investing long-term or not. The short-term technical patterns i.e. the way the DJIA line moves up and down quite possibly indicated a slow down in the momentum of rate of change thereby signaling purchases. In other words, less and less people might have began selling when the DJIA approached 10,655 which served as reason to lock in profits from selling-short i.e. buying stocks at an out of the money price to sell at a later point when that out of money price is in the money. High frequency trading algorithms are also designed to look for patterns in market buying and selling which can also accelerate short-term market efficiency.

That said, not much seems to have changed. The trade deficit, deficit spending, unemployment, and lack of strong consumer sentiment remain high, and economic outlooks for Asia and Europe are low or have been lowered. The U.S. may avoid a recession based on recent data, but not by much and that could be all it takes for the global economic engine to also gear down which itself tends to have an accelerator affect i.e. reactionary economics causes spending to slow until a realistic spending opportunity occurs.  

If countries are buying less, why spend more? Europe is spending all its money throwing good money after bad at flailing banks and inefficient economies within an environment of credit downgrades, and the U.S. government has no money left. Corporations claim to be too afraid of regulations, taxes and future economic conditions to justify spending their $1.8 trillion  in capital per the Washington Post, an amount  about $500 billion higher than the Federal fiscal budget deficit of $1.3 trillion per the Congressional Budget Office. That deficit will be added on to last years deficit and the year before that, it's high. 

Corporations are left in the driver's seat because last year government spending was included in GDP data, unemployment will hold back consumer spending and according to the Bureau of Economic Analysis (BEA), the "increase in GDP during the 3rd quarter of 2011 was due to a "decline in imports, and an increase in government spending in addition to fixed residential spending." Interesting how net imports and exports are included in 'gross national product'. Next year the American Recovery and Reinvestment Act funding will wane even more, and what to do with Bush tax cuts in an election year?

Why GDP can Decline with Improvements in Quality of Life

Quality of life decreases along with declines in Gross Domestic Product (GDP) due to an intrinsic correlation between the two. Consequently, GDP is the only measurement of progress needed. This article will expand upon the connection between GDP and quality of life in addition to illustrating why GDP is the more important of the measurements.

'Progress' is a relative term open to debate and depending on who one asks. However, if the concept of more is tied with progress, then more productivity as measured by Gross Domestic Product is not the only metric a society can attain increases in. More happiness, more health, more freedom, more rights etc. are all gains in life some might consider progress. 

A significant question of possibility emerges out of this divergent view of progress however. Specifically, can progress be sustained if other metrics of progress besides GDP and related measurements such as Job growth are not the only indicators of progress? In other words, can productivity continue grow side by side with other types of progress? After all, people might get lazy when they're happy so having more of other things considered progress might just be counterproductive to progress. This article will discuss other types of progress side by side with GDP in light of the above considerations.

Since Gross Domestic Product measures the total output of goods and services produced by a country, that measurement is a measurement of total material wealth produced for a given year as valued by currency prices for the cost of those goods and services. The first question one might ask is ,if the GDP were to decline, could other aspects of 'progress' continue to rise? For example, if there is less medical equipment, fewer doctors produced, less health care services etc. one can draw the connection progress in health care may also decline along with the decline in GDP if such GDP declines are comprised of declines in health related products and services. The result becomes less progress in this case, and may be further debilitated by declines in production related to other aspects of the economy.

To further illustrate, progress is linked to the economy and the economy is measured by GDP. While GDP is not the only measurement of an economy, it is a key indicator of the wealth available to a 'population'. The less wealth there is, the lower the standard of living becomes. Since standard of living is related to quality of life, a decline in GDP which is a measure of standard of living means there is likely to be a correlation between GDP and quality of life. So from this perspective, GDP is a measurement of quality of life in so far as the two are related. So why then does the question of quality of life indicators even arise? This is a good question.

The need for quality of life indicators can be thought of as a cry for help regarding disproportionate distribution of Gross Domestic Product. To illustrate, if everyone were to suddenly become rich, a great majority may find it simply unnecessary to work, or their productivity would decline in their lack of need to work. After a short while, inflation would rise, GDP would decline due to so many people being rich, and the quality of life would fall. Granted, some may still be motivated to work for love of labor, and other forms of gain such as social status, or even some kind of ethical conviction. However, the principles of human nature tell us, we are motivated by greed and that greed includes greed for a worry free life. That worry free life would end up leading to a decline in the overall quality of life.

So how can this apparent paradox between GDP and quality of life be solved? That is another question for another day. For the time being, one might realize quality of life is merely the call for more share of the GDP. If one is still not convinced of this relationship consider the notion of quality of life further. Love, comfort, harmony, amenities, entertainment, luxury, services etc. can't all be bought with money but certainly can be facilitated by wealth. 

Since wealth is measured by GDP at the macro-economic level, the correlation between the two is theoretically sound. As we have seen, a micro-economic distribution of GDP that is spread more evenly, has a strong possibility of leading to a decline in GDP and thus quality of life. Human nature is at the bottom of issue but who has the time to worry about that when everyone is chasing the GDP?

Introduction to the IS-LM Model in Economics

In terms of business, the IS/LM model in macroeconomics can help in assessing the likelihood of higher sales revenue using macroeconomic data. This can be done by testing statistical relationships against revenue using time sequenced macroeconomic data as projected through the IS-LM model.

What the IS/LM model should reveal to you is where an economy stands in terms of income, savings, interest rates and investing. Moreover, the IS/LM model in macroeconomics illustrates the relationship between these variables and at what levels they are balanced and steadier.  The IS represents income and spending, while the LM refers to lending and money supply.

The IS/LM model is the convergence of two economic graphs, one representing income and savings (IS) and the other money supply and demand. Interest and income are key variables in both curves i.e. According to 'The Economics of Keynes' by Mark Hayes, in the IS curve, interest is the independent variable meaning it influences the dependent variable of income.

In the LM curve, income is the independent variable that influences interest rate. However, also according to Hayes, related independent variables proposed by Keynes, the famous economist are lost in the IS/LM model. Hayes states these independent variables to be consumption, liquidity and income. Yet despite this it does seem evident the IS/LM model includes liquidity as a bi-product of low interest rates, and consumption a result of higher income.

To illustrate it helps to look at a graphs and explanations of the IS/LM model in macroeconomics. When changes in one variable take place, reactions in the other occur. For example, if the interest rates for savings increases, so does income that can affect investment and spending or the demand for money.

When the IS curve shifts to the right it means conditions are more favorable for businesses because there is more income, and a higher demand for money which is reinvested. When the IS curve shifts to the left, interest rates have declined, personal savings decreases, and demand for money has declined.

In a sense the IS/LM model is an economic indicator if how interest rates and income relate to investments and savings on a scale of Gross Domestic Product (GDP) and real interest rates. The steeper the angle of the LM curve, the more dramatically interest rates are tied to demand for money.

The IS/LM model in macroeconomics is also used to graph the affect of government fiscal policy on income, spending and GDP. If government spending is affective, the IS curve should lead to higher interest rates, increased GDP, and a rise in spending and income which also corresponds to an increase in demand and cost for money.

Just because an IS curve moves to the right doesn't necessarily imply it will benefit a business because it is a macroeconomic model. Macroeconomic models aren't directly related to single economic entities or variables, but rather are a composite or aggregate metric of such.

Sources:

1. http://bit.ly/hMmjJ1   (Roubini and Backus)
2. http://bit.ly/dLNmSK (Berkeley)
3. http://bit.ly/hZJMpI    (M. Hayes)