macroeconomic misconceptions

- Forget about textbook relationships between macroeconomic variables. Even the most innocent looking relationship breaks down in practice. For example lower interest rates may lead to deflation as opposed to inflation. Say a substantial number of consumers decides to lock up their income in cheap car loans to buy imported cars. Then these consumers will have less money to spend elsewhere. Assuming that most of the money spent on cars gets sucked out of the country and does not indirectly return to it, this change in consumer behaviour will create a deflationary pressure on the prices of goods for which demand has now diminished. If such goods carry more weight in the official inflation formula than cars do, then the reported inflation rate may become negative.

-There is nothing inherently wrong about excessive consumption. What is dangerous from a macroeconomic point of view is unsustainable consumption. If the rich desires to buy fancy stuff, that is fine. As long as this behaviour can be prolonged, the system will experience no shocks. On the other hand, if the government suddenly withdraws a subsidy which was supposed to be in place for at least several decades, then the system will experience a demand shock. The people who used to receive the withdrawn subsidy will change their consumption behavior, and the businesses which expanded their production capacities to deal with the increased consumption that used to be financed by the subsidy will suffer from an unanticipated decline in revenues. Even if the government decides to spend the freed-up money on other things (i.e. there is no absolute change in the aggregate demand), the system will still suffer a shock due to the change in the composition of the aggregate demand.