The Trump economic policy has been causing a lot of confusion lately, particularly with respect to the unbelievably low unemployment numbers, high GDP growth, and nearly non-existent inflation. This series of articles makes an attempt to try and explain all these discrepancies; although for some folks, it still may not be enough – but let’s try.
The figure shown is your traditional aggregate demand (AD) and aggregate supply (AS) curve (Keynesian). The vertical axis is price level and is usually measured as the consumer price index (CPI). The horizontal axis is the real GDP but discounted for inflation, usually in units of real dollars. The AD is simply consumption plus investment plus government spending plus net exports. AS is what the nation can produce to meet demand, and is usually dependent on stuff like resource costs (including wage levels) and technology.
When the two lines intersect, AD =AS. That means the economy is in equilibrium. The demand for goods is met by supply. The curves are not meant to address dynamic systems nor systems out of equilibrium. Nevertheless, the 3 areas marked on the graph have great significants relative to Trumponomics.
- This area represents a point of high unemployment. Resources, like people and factories, are idle. There is no price pressure on wages nor resources because so many resources are not being used. As the economy gets better, AD will shift to the right. Consumption and spending increase but not enough to put stress on resource costs until area 2 is reached.
- Area 2 is described as full employment – that is, resources are all maxed out. Now there starts to exists a pressure to push resource costs up. Labor, steel, office space, etc are now getting scarce and these prices can be bid up due to demand. The problem is that real consumption and spending cannot increase because fixed resources are all used up.
- Thus, area 3 indicates that demand for goods can increase superficially but not realistically. Real consumption and spending are fixed but the appearance of an increase in AD is only due to inflation. People get paid more money but resouces and infrastructure can only produce so much. Therefore, all the increase in wages is simply spent on higher prices.
Which brings us back to Trumponomics. Historically, the natural rate of unemployment is about 5% – that is the amount of unemployment that naturally exists due to workers hopping around to different companies looking for better opportunities. However, the Trump Administration states unemployment is down to 4%; and in some cases even below that. If this is the case, ultra low unemployment; then where is the inflation?
Some of the talking heads on TV have tried to say economics no longer follows the traditional rules; and we are in some mysterious new age of macroeconomics. I dont agree. Stay tuned to this series as we try to unpack what the pundits are trying to aberrate.