Many of today’s economic troubles are due to a fantastic guess.  That the wealth effect of inflated asset prices would stimulate demand in the economy.

The premise, as we understand it, was that as stock portfolios bubbled up investors would feel better about their lot in life.  Some of them would feel so doggone good they’d go out and buy 72-inch flat screen televisions and brand-new electric cars with computerized dashboards on credit.  Before you know it, gross domestic product would go up – along with wages – and unemployment would go down.  A self-sustaining economic boom would follow.

This fantastic guess, however, has proven to be a critical error in judgement.  Asset prices bubbled up, flat screen televisions and new cars were bought in record numbers, and the unemployment rate – according to the government’s statistics – went down.  On the flipside, real GDP growth only marginally lurched upward, never eclipsing 3 percent during a calendar year, and the great big economic boom that was supposed to save the economy from itself turned out to be a great big dud. Continue reading →