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Excessive Demand for Money

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"Excessive Demand for Money"

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I think a lot of the commentary and analysis of high corporate profits amidst weak hiring is kind of missing the picture:

Many companies are focusing on cost-cutting to keep profits growing, but the benefits are mostly going to shareholders instead of the broader economy, as management conserves cash rather than bolstering hiring and production. Harley[-Davidson], for example, has announced plans to cut 1,400 to 1,600 more jobs by the end of next year. That is on top of 2,000 job cuts last year — more than a fifth of its work force. [...]

“Because of high unemployment, management is using its leverage to get more hours out of workers,” said Robert C. Pozen, a senior lecturer at Harvard Business School and the former president of Fidelity Investments. “What’s worrisome is that American business has gotten used to being a lot leaner, and it could take a while before they start hiring again.”

It’s important to think harder about this. What would it mean for benefits to flow to shareholders rather than to the broader economy? Suppose Harley-Davidson increases profitability by laying off workers, then rebates the extra profits to shareholders as dividends thus benefitting them. Well then they’re going to take their money and buy some stuff with it. Maybe Harley-Davidson shareholders want to get their kitchens redone or they want to go visit Miami or whatever. This is the whole reason economic growth works—distributive issues matter, but economic interactions aren’t zero-sum and when some people are getting more prosperous the benefits of that prosperity normally flow around a bit. As an alternative to giving money back to shareholders, a profitable motorcycle firm that doesn’t want to expand its own capacity could always save it in a way that finances some other firm’s investment. Indeed, this is what the financial system is for.

But when you look at the economy as a whole, you see that this circulation of funds into either consumption or business investment isn’t happening. Just looking at one firm (increasing productivity, flat market) and then generalizing doesn’t tell you the whole story. The issue, system-wide, is that there’s a huge amount of demand for cash and other very safe, very liquid instruments. As a result of this cash shortage, there’s a glut of nearly everything else and that’s leaving many potentially productive resources idle. The Federal Reserve could almost certainly solve this by pushing up inflation expectations which would reduce the demand for cash and therefore increase the demand for things that aren’t cash. But its leadership doesn’t seem to want to do this, perhaps because it’s still pursuing a strategy of opportunistic disinflation.

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