It sounds like we are about to crack a bad joke but bear with us because they do have something in common. They both cannot work without liquidity.
In an attempt to understand the stock market key elements of the bathtub b have been associated to key element of the markets in an attempt to simplify and explain their function in the overall picture.
Without further ado let us break this economic bathtub down and its elements: and you will see how quickly it all comes together.
The Tap represents the central bank. Similarly, to the tap controlling how much water goes into the tun into a tub, a central bank is the main source of financial liquidity to the economy. When changing monetary policy, it is just like changing the flow of water from the tap.
The Drain symbolises the flow of funds that get drawn into the real economy. Nevertheless, not like tub water going into the sewer, monetary flows provide liquidity to many facets of a dynamic economy. Supremely of course, this would lead to economic expansion and growth, wealth creation for everyone and an overall increase in a nation’s standard of living.
The Spa Jets are a symbol of the impact private sector banking activity has on the economy. Economists describe this as the “multiplier effect,” where money is re-circulated into the economy as money is deposited and then re-loaned by the private banking system. This provides confidence to people and makes activity flourish in the real economy, and so the spa effect starts becoming more and more prominent.
The Water Level in the tub communicates the net surplus funds (i.e., not being pulled into the real economy) which in essence are funds available to investment markets. The dynamic interaction of the above factors, is the grand determiner of the water level.
The Suds Volume is a symbol of the state of an investor’s expectations. It too also relies, on all of the above components. Too many expectations result “in suds overflowing the top of the tub whereas low points are nothing more than a soap scum on the water’s surface.”
We think the bathtub analogy is a great and simple way to explain the intricate ways an economy works and the repercussions of having too little or too much money in the economy ie. Recession inflation.