Saturday, December 22, 2012

Roger Farmer on Wealth and Unemployment

I heard a lecture this semester by Roger Farmer who is the Chair of the Economics department at the University of California, Los Angeles.  Dr. Farmer is different from most economists in that he is attempting to address the 2007 recession from a new perspective.  In a previous post I mentioned that there are the Keynesians, and the Hayekians.  There is also Irving Fisher who explained the 1929 depression in terms of a debt-deflation cycle.  Dr. Farmer explains Fisher by pointing us to look at the end result of Fisher, which is wealth.  It is wealth that is lost once a debt-deflation cycle occurs.  This is equity on the balance sheet, and in financial terms, it is that residual value in our own individual financial structures that allows us to borrow in order to buy things.  It is the basis for our own personal leverage.

When the 2007 Great Recession hit lots of personal wealth was wiped out.  Some estimates put it as high as 40%.  This restrains consumption from a Fisher perspective.  However, Farmer makes wealth a more central part of his economic argument.  He bases much of his argument on Milton Friedman, whom he described as a Keynesian.   Friedman stated that consumption is based on wealth and not income, which is counter to a traditional Keynesian argument that wealth is based on income.  I know what you are thinking, but I am just reporting what I heard.

Dr. Farmer presented several graphs that brought his argument into focus.  He traced unemployment through the 1930’s and showed how growth in employment marched hand in hand with the value of the stock market.  He then used this information to build a model of the relationship between the S&P and unemployment over fifty plus years.  He used the first have of the years to establish a foundation of data for the model.  He then used those years to predict unemployment from the 1980’s to more recent years, and the model was incredibly accurate.  He demonstrated that wealth and unemployment move together, and wealth can be used to predict the level of unemployment.   

What are the policy implications of this?  Dr. Farmer proposed a solution that could be received as a “big brother” type of method to stabilize the economy.  He proposed that the Federal Reserve establish an indexed fund of stocks.  The term “index fund” means to buy a set of stocks from the market that mirrors the overall market.  The idea is not to buy a set of winners over loosers.  The fact that the Federal Reserve would buy an indexed set of stocks to stabilize asset values in down cycles would also protect employment from moving to the downside in the proportions that it has in the last five years.

My own personal recommendation is not to tax capital, because taxing capital would retard its growth.  If you want employment to grow, wealth should grow.  

Dr. Farmer has a little book that I recommend to anyone who wants to understand the economy, but who has not the time or the patience to suffer through a college course on the subject.  The book is How the Economy Works and it is available on most bookseller web sites.  Dr. Farmer’s own web site with his mathematically based technical working papers is linked here as well.

The idea that wealth relates closely to unemployment is not a new idea, but Dr. Farmer has been able to put together persuasive evidence that the relationship is real.  

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