Upside-down Economics

There has been a disturbing theme underlying the economy since 2007 -- dynamics everyone thought worked reliably and were inviolable don't seem to work anymore. Housing and real estate were supposedly the bedrock of the middle-class economy, and were safe, boring investments. Lower interest rates were supposed to drive lending and business growth. Lower unemployment was presumed to drive consumer spending. Lower oil prices have traditionally spurred spending and helped move the stock market upward. Higher corporate profits have customarily driven reinvestment in infrastructure, new lines of business, and so forth.

Instead, we have macroeconomic puzzles -- lower interest rates, yet higher rates of savings; lower oil prices sending shudders through the equity markets; an unprecedented housing market collapse and a tepid recovery; lower unemployment and stagnant consumer spending; large corporate cash stores being used for stock buybacks, if they're being used at all.

There are many factors feeding into this puzzling set of circumstances, but skittishness seems to be the overall theme. Individual consumers are paying down debt and bolstering their savings; businesses aren't seen opportunities that fit their new, lower level of risk tolerance; and more opaque international markets (e.g., China) which themselves are looking skittish are causing equity traders to read too much into decreased oil revenues.

It's a strange new liquidity trap, but like those we've seen in Japan, for example, it is psychological. After all, money itself is a construct, and therefore it matters very much how we think about it -- when to spend it, how to get more, and when to sit pat.

The Federal Reserve is seeing some success stimulating inflation, which was at a 2.7% annual rate in January 2016. This is an important part of escaping a liquidity trap, as inflation drives prices, increases wages in the lower tiers of the workforce especially, and stimulates loans. This trend will likely continue, which will become a factor for pricing in the academic marketplace, as well. Cost-of-living increases are often pegged to inflation, and businesses benchmark profitability up from this measure.

Until the economy is growing at a healthy pace again -- with inflation being a good reflection of that pace -- the muddled results of the past decade may continue. With inflation, we can see once again which way is up, and only then will some of the main economic levers respond sensibly once again when pulled.