Future of the Economy #2(a) – Rich Hypothetical Society, Poor Hypothetical Society

Earlier today, I was on a plane without wifi. Trading one type of cloud for another freed me to continue my gradual explication of our economic future.

Last time, I argued that “the economy” is the total sum of everything useful to human life, and that “prosperity” is the sum of all those resources divided by the number of people enjoying them.

Today, I’ll cover why and how the prosperity of a society changes through time.

We’ll need three more concepts:

1) Production

2) Consumption

3) Wasting (e.g. rotting of fruit)

Tautologically, everything man-made was produced at some point. So:

Total amount of stuff we have (i.e. “Wealth”)

equals

( Natural Resources plus Everything Ever Produced )

minus

( Everything Ever Consumed plus Everything Ever Wasted )

Prosperity changes because of relative changes in the rate of production vs. consumption. Societies get richer when they produce more than they consume, and get poorer when the consume more than they produce. This may seem obvious, but all the crucial parts of macroeconomics spring from this notion.

Why do these rates change? Three reasons:

1) Exogenous

2) Cyclical

3) Secular

Exogenous reasons are usually-random, usually-one-off events like wars or gold strikes. Cleary, being sacked by Mongol hordes makes you poorer, and I won’t cover these types of events here.

Cyclical reasons are what underlie normal recessions and expansions, and (by-and-large) are caused by changes in the amount of money people borrow to consume or invest. When people borrow and buy a lot, we have an expansion. When they borrow less, we get a recession. The most important factor in consumer borrowing is the interest rate (how much do I have to pay tomorrow for the $10,000 car I bought today?) People who can explain exactly what determines the prevailing interest rate tend to spend more time on mega-yachts than in coach class on US Air, but basically: the interest rate is set by the Federal Reserve based on (a much more complicated version of) an equation called “the Taylor Rule”. Cyclical factors get a lot of attention because their effects are easily and immediately noticeable (and crucial to trading financial markets), but ironically, cyclical factors usually matter very little to long-term prosperity (for the same reason that most waves don’t affect the sea level.)

I’ve hit my self-imposed word limit, but next time I’ll discuss secular reasons, which – forgive the pun – are where the money is

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