Back in the day, macroeconomists used one of two models to think about how central banks steer economies. For a big economy, with modest international trade and capital flows, the model ignored the rest of the world. The central bank, by changing liquidity conditions, raised and lowered interest rates. Changing interest rate levels drove interest sensitive sectors up and down, thereby tightening or loosening slack in the economy. Inflation rose or fell, depending upon the tightness or slack in domestic markets. For a small economy, with large international trade and capital flows, the model highlighted rest of the world dynamics. In this model, global capital markets set the interest rate. The central bank, by changing liquidity conditions, raised or lowered the value of the currency. A rising currency would restrain growth and weigh on inflation. A currency in retreat would do the opposite. The U.S. was the poster child for the large closed economy. Canada was the prototypical small open economy. Continue reading
…the disconnect between retail sales and jobs. But check out this chart:
The same thing happened in the mid 90’s, an absolute boom period. What was going on….? Gas prices collapsed, just like now. Gas as a percentage of total sales has dropped by a third. Even stripping out gasoline isn’t totally clean either – the likes of Costco, Walmart and WaWa all sell gas as well.