Economics is much simpler than many highly paid pundits would like you to believe. At the same time, it's also much more complex than it might appear initially. For instance, why are there so many economic pundits when all they do is make predictions that often prove wrong (see nearly any of the reporting that preceded the Great Recession)? Are they really adding value?
Not all forecasts are a waste of time. Forecasting and tracking of weather have improved dramatically since the 1970s.
Radar, storm tracking, pressure readings, shared resources and, more recently, observers on the ground who provide their own video of weather as it occurs have all gotten more sophisticated -- and more reliable -- in recent years.
But economic forecasting seems far behind this technological wave. While there might be more data, more computing power and more tracking, there is little consensus on what data to follow or what actions might help create a more pleasing economic climate.
Of course, forecasting weather, which people have no choice but to endure, is vastly different from tracking economic activity, which people would like to control.
On the microeconomic level, which deals with individual people and firms, it may seem easy: People spend the money they earn. Companies invest capital in land, buildings, equipment and people to produce products and services. When these newly created products and services are sold, the companies can then pay their employees and repay the bank or investors and, with any luck, retain profit as a reward for having taken the risk.
Those companies that make a profit by providing a good or service worth more than what it cost to create it grow. Companies that cannot create a profit go out of business over time.
This fundamental framework becomes more complicated as financial structures are layered over the foundation. Houses can be bought with mortgages; second mortgages can be taken out for renovations, cars or even credit cards. Cars can be bought with cash or a loan or simply leased. Furniture can be taken home with no down payment and no payment for month or years. Credit cards can be used for cash advances.
This overlying framework, designed to provide ease and to allow many more people to participate in home ownership, the luxury car market or the you-name-it market, only works if the people who participate meet their obligations. In other words, if they pay off in the future what they have agreed to today.
One person's inability to repay leads to his or her personal bankruptcy.
What does this mean from a macroeconomic perspective when lots of individuals go down this same path?
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