If Economists Knew Arithmetic

Dean Baker.

There are several articles floating around with the general message that an uptick in the stock market or bank profits does not mean that the economy is finally “fixed”. I’ll try to post a couple Real Soon Now.

If Economists Knew Arithmetic, We Might Waste Less Money on Banks

There is no doubt that the economy would be better off if most of our banks were not insolvent, but only those who are really bad at arithmetic would think that repairing the banking system will restore prosperity. The economy would still be faced with a massive shortfall in demand with the unemployment rate soaring into the double digits.

The basic problem is that the economists who missed the housing bubble (EMHB) somehow still don’t understand how the bubble drove growth earlier in this decade. There were two main channels:

Residential construction expanded from its average of 4 percent of GDP to more than 6 percent of GDP at its peak in 2005; and

Consumption boomed based on ephemeral housing bubble wealth, as the adjusted saving rate turned negative over the years from 2004 to 2008, compared to a post World War II average of 8 percent.

The collapse of the bubble has derailed these engines of growth. Housing construction is now less than 3 percent of GDP and the adjusted saving rate is approaching its post-war average. This is why the economy is slumping and the unemployment rate is soaring. There is no sector that can readily fill a gap in demand in the neighborhood of 8-9 percentage points of GDP. …

There’s more, of course.

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