Is there an economic recovery, or not?

Monday, October 20, 2014

By Farrokh Langdana, Director, Executive MBA Program & Professor of Finance and Economics

Faculty Blog:

Is there an economic recovery or not is essentially what is on everyone’s minds.

To find out, we have to go back to classic macroeconomics and look at the composition of the Gross Domestic Product (GDP):

Y = C + I + G + (Exports - Imports)

Y = national income (GDP)
= private consumption
= capital investment
= government spending
- Imports = trade balance

C is the main item here. Until C (private consumption) recovers, there is no real recovery, as C is 70% of Y. C is driven by:

C = C + by + dW

C = consumer confidence (commonly referred to as “Cbar”)
= the marginal propensity to consume which is about 0.9
= national income
= the sensitivity of changes in consumption, C, to changes in wealth where d is presently 0.2, which means that if wealth changed by $1, C would change by only 20 cents.

W = wealth (or “disposable income”)

If W is increasing, C should too, BUT d is a small number (only 0.2), so even if W increases, the effect on C, while positive, will be small...but then also note that the index of sentiment of the National Association of Homebuilders is at its highest point since 2005!

The American economy heavily depends on three things: housing, housing, and housing. Both consumer confidence (C) and W will be driven by it, and ultimately, C, the key driver in an economic recovery.

So is there a recovery?  Once the correction in the stock market burns off, there is traction – weak, anemic, but still there. And frankly, it’s better to have long, slow, real growth based on solid fundamentals, than to be in a raging speculative asset bubble. The former is boring, the latter is exciting. Sometimes it’s good to be boring and may the economic recovery be boring.

TAGS: Business Insights Executive MBA Farrokh Langdana MBA Thought Leadership