I had an exchange with Tom yesterday that reminded me how close I came to flunking macroeconomics.
You might not believe it, given my understated brilliance, but I really struggled with advanced macro. I was never great at studying: I lacked the diligence it required and attending college at the dawn of the era of streaming digital video didn’t help. But I had no problem with microeconomics because it made sense. Marginal utility, demand elasticity, interest rates: once the right people explained it to me, I understood it. I reasoned my way through problem sets, rather than spitting out stock answers, and did fine. (I still would have done better if I studied)
But macroeconomics resists that kind of intuition. Take the following quiz question, for instance:
All other things being equal, raising interest leads to _____ in aggregate demand.
(A) A rise
(B) A fall
(C) No change
So I think:
Well, raising interest rates encourages more people to save, which increases the funds available for borrowing, which means banks have more money to lend out. It would also draw more banks into the credit card market, since payoff terms become more favorable for the lender, thus increasing the sources of available credit. Of course, there would also be a decrease in borrowing, as fewer people would want to take out loans. It’s tough to tell which effect would outweigh the other, so I’ll presume they cancel.
At which time I put (C) and am told I’m incorrect. The correct answer is (B).
As it turns out, my answer is also correct depending on when you stop counting. Raising interest rates does (or should) encourage people to save and invest. Raising interest rates also does (or should) increase the profits of credit card companies, and the more profitable a field the more competitors enter it. But all of these effects manifest in the long run. In the short run, an increase in interest rates lowers aggregate demand.
The problem is that it’s always the long run. Today’s “long run” is next year’s “short run.” And today is the “long run” of four years ago. “The market will correct the price of these subprime mortgages eventually.” “We need companies to start spending now; we can deal with the consequences of bailing them out later.” Now is later! Today is the future of the past! We’re on all corners of the four-dimensional timecube simultaneously!1
Not to bury the lede, but this return to my prodigal youth came up after I linked to this lovely chart on income stagnation2 from The Economist. In 2010 dollars, income for the bottom 10% of America has been largely steady since 1967 and hasn’t improved much for the median 50% either.
I made the observation that average prices have gone up about 6X in that time (which is true; check for yourself). Tom asked me if this observation still mattered, given that inflation was already baked in to the rise in median income. I had to plot the reasoning out in my head several times to answer him because, again, macroeconomics does not come naturally to me. Ultimately, Tom was right to correct me, since people aren’t 6X worse off today than they were forty-five years ago. But I was still on to something.
If you’re in the 50th percentile of American households today, your income is about $50,000 in 2010 dollars. A household in similar straits in 1967 would have an income of about $40,000 in 2010 dollars. However, a new car in 1967 would cost about $17,755 in 2010 dollars (source); a new car today costs $29,217 in 2010 dollars (source). So the price of a new car has gone from about 44% of a middle class family’s income to … about 58% of a middle class family’s income.
This isn’t as damning a statistic as it sounds. “Middle class” is not an absolute term; it only means something in relation to the folks above and below it. If things besides income are getting better for everyone (like the quality of goods, hypothetically), then the relative allocation of prices doesn’t matter as much. And the people who were middle class in 1967 most likely weren’t middle class in 2010, if they’ve survived. But what’s noteworthy is that households in the top 10% haven’t suffered the same fate. While their membership isn’t absolute either, it tends to be stickier.3
We think of inflation as a force that weakens the purchasing power of a dollar. This is true. But inflation can also lift the wages we receive, since employers pay more for labor while we pay more for groceries. So you’d think it all evens out – until you see a chart like this. Then we recall that inflation enters the economy through an increase in the money supply. And even though an increase in the money supply trickles down to everybody, it hits those with easy access to credit first. The defense contractors, the institutional investors, and the ones with an inside scoop on appropriations. They get the “first batch” of new money – still warm to the touch, juggling steaming Andrew Jacksons from hand to hand – before people start raising their prices.
Don’t take it from me, though. I nearly flunked macroeconomics.
1. Do I even need to link to Timecube anymore? They still hand that to you on your first day of Internet, don’t they?
2. Apologies for that “opinion cloud” sidebar, which is completely fucking up my browser.
3. “Families are always rising or falling in America, am I right?”
“Who said that?”
“What’s the matter, smartass, you don’t know any fuckin’ Shakespeare?”