Let me take a moment to appreciate this video. Not only does the narrator explain well but the awesome animation makes it fun and easy to understand as well. Gives basic knowledge of how the conventional economic system works. I found this video really useful cuz the overall picture of the economy itself gave answer to some of my previously inquired questions. Also made me realize- having knowledge about economy helps to understand history better too.
Today's post can be considered as a summary or a guide to get the big picture of what's been covered in the video. As I've mentioned before, the economy discussed here is the conventional economy where debt comes with an interest rate.
Three main forces that drive the economy are-
1. Productivity growth
2. Short term debt cycle
3. Long term debt cycle
Productivity growth shows how productive a country's been over a long period of time. Increased productivity leads to increased living standard.
Here you can see 'productivity growth' has a straight line going upwards which means that it's not responsible for 'economic swing'.
But for the other two, the curvy lines say that things don't always go upwards in these cases. All the problem happens in the part where the line goes downwards.
Laying these three lines on top of each other shows the movement of the economy-
So if we want to understand the why economy fluctuates, we need to understand the short term debt cycle and the long-term debt cycle.
If you watch the video, you'll fully understand what these two are and how they occur. Here I'm going to point out the key differences between them.
One long term debt cycle consists of many short term debt cycles- as you can see from the graph. It takes 75-100 years for a long term debt cycle to complete whereas the duration of a short term debt cycle is 5-8 years.
At the peak of a short term debt cycle, spending becomes too much. But the quantity of products doesn't rise as much. So, prices of products rise and inflation becomes a problem. To solve this issue, the central bank increases the interest rate. As a result, borrowing decreases and people spend less. Thus prices drop and the inflation problem is solved. However, since spending drives the economy, less spending causes economic activity to decrease. This situation is called recession. Now the central bank decreases the interest rate again. Spending increases and everything goes back to the normal situation.
On the other hand, in the long term debt cycle the problem starts when debt repayment starts growing faster than people's income. And that's why people start spending less. Less spending means less income. And less income means people can borrow less. Less borrowing leads to even less spending. People can't even pay their debt repayments. Thus economic activity keeps going down the drain. This situation is called deleveraging.
What's noticeable is that- the situation is under control of the central bank in the short term debt cycle. Because the spending is controlled by controlling the interest rate. But in the long term debt cycle, the situation is out of control of central bank because here spending is reduced not because the central bank did something but because the debt repayment got too high. Short term debt cycle causes recession and the long term debt cycle causes deleveraging. The way to get out of a recession is to decrease the interest rate whereas to getting out of a deleveraging is much more complicated. It is done by balancing between inflationary method (printing adequate amount of money) and deflationary method (cutting spending and debt reduction).
So that was the boring (not really) stuff I reviewed with so much interest. :) With the hope of posting again next week, I'm putting an end to today's post.
Stay safe. 🌻