Regardless of what we are always being told by the venerable Pantheon of pedigreed Economists out of Washington, DC, Wall Street, and academia (as well as by the seemingly cynical grumblings of self-professed "Main Street" economists -- I am one of those myself -- and I have growing misgivings regarding the utility of my undergraduate degree in Economics) regarding the state of the our sovereign finances, most of us develop a powerful "feel" for how well the machinery of monetary and fiscal policy are working by our own personal finances.
If my income is increasing, but at a lower annual rate than my ordinary living expenses (including my repayment of the debts which I incurred to either live beyond my means or to purchase investments that my neighbor (a smart fellow) said were "sure things") are increasing, I feel a decline in my sense of well-being. My finances are continuously getting tighter. This seems to make sense (except to people who don't have any ordinary concerns about income and expenses, and such dull pedestrian pastimes as "working for a living.").
This difference in rates of growth between income and expenditure are what wallop us in our respective wallets.
The Facts (which are actually fictional):
John Q. currently earns post-tax income (similar to actual cash inflows) of $80,000.00 per year. His post-tax income grows at a rate of 2% per year, compounded annually.
John Q. has annual expenditures (to cover his living expenses and to service payments on his mortgage and other debts) of $50,000.00 per year. His annual expenditures grow at a rate of 10% per year, compounded annually. He doesn't buy fancy new things, and replaces old, worn-out ones with their equivalents, as necessary. John Q. is a "middle class" sort of chap.
Initially, the difference between John Q's Income and Expenditures is $30,000 per year.
The growth rate difference between John Q's Income Growth and his Expenditures Growth is 8%.
What will be the effect on John Q's quality of life (i.e., his ability to cover his expenditure obligations with his income) over the next seven years?
Answer - Two Comparable Graphs:
Note: Special thanks to Kids' Zone Graph Creator (from Learning With NCES), at http://nces.ed.gov/nceskids/createagraph/default.aspx, for providing me with the tools to create these graphs. Haven't you noticed how much easier it is to explain things and to understand things by using graphs and charts? Graphs and charts are wonderful learning tools -- we should use them more often. They engage more of our senses in the learning experience than just sitting about and listening to unsupported rhetoric.
Answer, In Ordinary Terms:
With each passing year, the margin between John Q's income and his expenditures decreases in real terms. By the end of year seven, John Q's "safety margin" has decreased from $30,000.00 per year to approximately $2,000.00 per year. Things are getting much tighter. John Q. is so worried that he is cutting back on his expenditures wherever possible (this hurts businesses, some of whom employ persons like John Q.) and is living in a state of growing desperation and fear.
Regardless, of what the experts say about recession, recovery, leading economic indicators, monetary policy, fiscal policy and different legislative packages, John is beginning to feel like he is a member of the "working poor." He cannot accumulate any significant savings, and can't find a new job -- it seems that fewer businesses are hiring, and more employees are worried about keeping their jobs.
The difference between growth rates (or price rates) is the chasm that economies fall into. The less the disparity between growth rates, the greater the grassroots perception of the economic picture. The problem is that some legislative policy makers, mainstream media sources and otherwise well-intended politicians either don't quite understand this arithmetic (let's call it "dangerously divergent rates of growth"), or, if they do they may present inaccurate or irrelevant statistics compiled by incompetent people.
I hope that you enjoyed this lesson in Real Economics, and that you'll forward this article to all of your friends, colleagues and elected officials. As always, thank you for reading me here at Braintenance.
Douglas E Castle