Roaring twenties are labeled as the birth of modern day America. Wages were high, employment was abundant, credit was easily available, revolutionary inventions like automobiles, radio, talkies, Jazz and washing machine were becoming the necessities for everyday life. It was the rise of consumerism, and happy and carefree life. Part of this was due to the expansion in money supply and inflation caused by Federal Reserve’s easy money policy. The demand for goods and services rose very quick, to a very high level. It was so quick that industrial sector couldn’t adjust fast enough. The shortage of manufactured goods and related supplies ensued.
Fed was keeping interest rates low and discount windows open, since 1920 Depression. This was causing a great deal of inflation. So, Fed decided to raise interest rates and tighten the money supply. Due to less and expensive money supply, businesses could not keep up with the roaring demand. Recession was mild from every stand point. Although it teaches us a very important lesson. Inflation causes recessions. Ironically, governments try to fix recessions and depressions with the help of inflation. It just sets the economy for another downturn. It is because the interest rates cannot be kept very low for very long periods of time.
Lower interest rates increase money supply and devalue it. Due to money devaluation prices go up. Standards of living fall and cost of doing business goes up. Higher cost of doing business affects jobs market and wages. Employers can now afford fewer employees and can pay them less. Necessary investments in R&D, expansion and start-ups suffer. Ultimately it becomes absolutely unavoidable to deflate the economy. So, Fed raises the interest rates and tightens money supply. This curtails the money supply in an already inflated market, and causes recession. Markets take some time to adjust to new reality. Unfortunately, most governments and central banks get scared with this situation and do not allow markets to adjust.
They go back to the policy of lower interest rates and easy money supply. This starts a new cycle of inflation, all over again. Each time the new set point is setup at a higher level and the situation keeps getting worse after each cycle. Debts and deficits keep rising. Cost of living and doing business keeps going up, affecting jobs and wages. The net result is a continuous decline in standards of living because under these circumstances wages cannot keep up with inflation.
On the other hand, if central banks and governments do not interfere with markets and allow those to adjust, the reduced demand in recession would suppress prices and reduce the cost of living and doing business which results into a rise in standards of living and improves savings. Improved savings spurs investments start-up, business expansions, increasing the demand for real estate, machinery, supplies, raw material, associated distribution and retail, and labor. Increased demand for labor takes care of unemployment, under employment and depressed wages caused by recession. Reduced unemployment and higher wages raise demand causing increased production. Increased production creates jobs and raises wages. We can see how the long term effects of free market adjustments are so different from artificial fixing by central banks and governments.
This can easily be understood by comparing current state of affairs from what it was about hundred years ago. For example, what would cost $20.00 in 1913, now costs 472.56. The cumulative rate of inflation in this period is 2262.8%.
Another effect of these bailouts, QEs and easy monitory policies is income inequality. These are done at the expanse of tax payers. But, most of this money just goes and gets accumulated in the accounts of rich people, big corporations and banks.
For example, the income of bottom 20% increased by 16% during the period of 1979-2007. In the same period, top 1% raised its income by 281%. Beside Federal Reserve and government bailouts the major cause are ever growing government regulations which make it difficult for start-ups and small businesses to survive. More and big corporations are now establishing their monopolies. They have very less or no competition from small businesses. Hence, they can do whatever they want. They can set prices, promote and fail brands and companies and pay whatever they want to their employees. Due to monopolies, employees have no choice except to accept whatever the only or very few available employers are offering in their field of education, expertise and experience.
A very good example of these income inequality effects of government interventions is recovery from 2008 recession. During the period of 2009-2012 top 1% percent grabbed the 955 percent of gained income during this period. The real wage gains which are inflation adjusted, in 1920s when government interventions were negligible, was about 20%. As opposed to that the wage gain in the last quarter of 2013 was less than inflation rate, when the market interventions from government and fed are incredibly high.
This is because the fiat money being generated by Fed for rescue and stimulus packages, and QEs is merely inflating the stock market. Most of the stocks are owned by high income people. So, they are the people who are getting all the benefits. Since a wages are stagnant, unemployment and under employment is not coming down significantly and inflation is high, average Joe is yet to see the real recovery. Little or no increase, and even fall in real wages is compromising over all standards of living. As a result, already low savings are declining even further. Less savings means less investments, equals no real recovery.
In short, there is no point in prolonging our agony and risking another, yet worse downtrend. Fed and government must back-off. Let interest rates adjust to market. This will suppress demand and prices. Lower prices will raise standards of living and raise savings. More savings mean more investments which will spur the start-ups and business expansions. Start-ups and business expansions create jobs and demand for workers. It means more people will be working and demand for labor will raise the wages. More employed people with higher wages will result into more savings. More savings means more investments and cycle goes on.