Blanchard: Prices are the key to a brighter economic future

Wednesday, September 3, 2008

According to Olivier Blanchard, former MIT Professor of Economics and newly appointed Director of the IMF’s Research Department, "If the price of oil stabilizes, I believe we can weather the financial crisis at limited cost in terms of real activity." I concur, having argued that there is indeed no credit crunch in the US.

Oil falling is the best news for the US Outlook. Blanchard indicates that it is prices (inflation) that are the true source of the global economic slowdown, rather than the financial turmoil of late. Let’s use US consumption growth to illustrate this point.

The chart plots annual real and nominal consumption growth patterns on a quarterly basis from 2005 to 2008 (Q2). Nominal consumption growth is trending upward, while real consumption growth is trending downward. Consumption is 70% of US real GDP, and prices, where the latest headline inflation rate was 5.6%, have really taken a toll on consumer spending.

In my opinion, the reduction in oil prices that have brought likewise reductions in gas and energy costs is the biggest and most positive news to date regarding the Outlook of the US economy. As long as inflation abates, consumers will have more money to spend, resulting in higher aggregate consumption and stronger economic growth.

Please leave comments. Best, Nontruths


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