As I mentioned yesterday, one BIG problem with the traditional business cycle model (the one taught in business schools) is that although it explains what happens abroad, it no longer fits with behavior in the US economy–which is, after all, the biggest in the world (for believers in purchasing power parity, the second-biggest …after China).
The model says that lower interest rates energize business capital spending, which produces new hiring, which leads to higher consumer activity as new employees spend their paychecks.
the US experience
In the US, however, consumer spending recovers first. Typically, soon after the Fed begins to lower interest rates, US consumers have been back in the malls, spending up a storm. Rather than industry lifting the consumer, the consumer pulls industry out of its slump.
Economists theorize that what’s at work in the US is the “wealth effect.” Two aspects:
–maybe lower rates are like Pavlov’s dinner bell ringing and consumers begin to salivate in advance of recovery (my personal take on this is idea that the office/plant grapevine signals that the worst is over, that layoffs have stopped and new hiring will soon begin)
–lower rates = house prices start to rise, as do bonds and stocks. So consumers feel wealthier as rates fall, because their accumulated assets (their wealth) are worth more.
The problem here is that we’ve had zero rates for eight years without seeing the traditional recession-ending spending surge
where’s the capital spending?
Whether capital spending is the locomotive or the caboose, it’s still arguably an integral part of the economic recovery train. Why haven’t we seen a capital spending surge in the US? Is the lack of capital spending an indication of continuing weakness in the US economy, as the traditional business cycle theory would suggest?
I think four factors are involved here, the sum of which suggests reality has sped far ahead of theory:
–the internet. Typically, there’d be a surge in construction of shopping malls as recovery gains speed. But as online commerce has developed, we’re finding that we already have maybe 20% too much bricks-and-mortar retail space
–globalization. Continuing industrialization in emerging economies like China during the last decade has decisively shifted lots of low-end US-based manufacturing abroad. In addition, I’m also willing to entertain the thought that crazy spending in China has produced an enduring glut of manufacturing capacity there, although I have no hard evidence
–software. For many (most?) US companies, the largest target for new investment spending is not bigger, newer plants but faster, more efficient software. The National Accounts, the government system of tallying economic progress, have no effective way of recording this expenditure for analysis. The traditional business cycle picture is similarly stuck in the world of fifty (or a hundred) years ago
–skilled vs. manual labor. This is a thorny issue, and one I have strong opinions about. Here, I think it’s enough to say that the traditional model doesn’t distinguish between a twenty-year old with a grade school education and a strong back vs. a college dropout like Mark Zuckerberg. A generation ago, the distinction wasn’t important. today, it’s crucial.