There is an informative article in the May 12, 2016 issue of Bloomberg Businessweek, “How to Pull the World Economy out of Its Rut.” Recall that Janet Yellen succeeded Ben Bernanke as Chair of the Federal Reserve in January 2014. The other candidate for the post was Larry Summers. They have rather different views about the role of a central bank:
Janet Yellen insists that economic conditions are returning to normal, even if slowly. She is neutral about the slow growth, secular stagnation hypothesis and using fiscal stimulus to overcome it.
Larry Summers argues that world growth is stuck in a rut because there is a chronic shortage of demand for goods and services. Growing inequality puts a bigger share of the world’s income in the hands of rich people who spend less. The new economy is asset-lite (Uber and Airbnb prosper by exploiting existing assets) and so needs less investment. Software doesn’t require the construction of new factories. He thinks that central bankers should spend more time and effort trying to influence fiscal policy. For example, more government spending on infrastructure, global warming and improving education. Also changing the tax code to put more money in the hands of lower- and middle-income families who would spend it.
I think that they are both partly right and partly wrong.
Janet Yellen is correct in believing that the Fed should stick to monetary policy. But she is too cautious in raising interest rates back to more normal levels. There will be some (stock market) pain in accomplishing this but it needs to be pushed faster regardless.
Larry Summers is correct in calling for action on the fiscal front. But his suggestions for how to do this are mostly off base because they will lead to massive new debt which must be avoided.
So what is the proper course to get out of our economic rut? It is what I’ve been saying over and over again but I’ll repeat it for good measure in my next post! Stay tuned!
The U.S. economy has grown at the rate of only 2.2% since the end of the Great Recession in June 2009. This is much slower than the average rate of growth of 3% for the past fifty years. The economists Glenn Hubbard and Kevin Warsh, writing in the Wall Street Journal, “How the U.S. Can Return to 4% Growth,” point out that:
After the severe recession of 1973-1975, the economy grew at a 3.6% annual real rate during the 23 quarters that followed.
After the deep recession of 1981-1982, real GDP growth averaged 4.8% in the next 23 quarters.
Recent research has shown that steep recoveries typically follow financial crises.
The economist John Taylor, also writing in the WSJ, “A Recovery Waiting to Be Liberated,” explains that the growth of the economy, i.e. growth of GDP, equals employment growth plus productivity growth. He then points out that:
Population is growing about 1% per year. However the labor-force participation rate has fallen every year of the recovery, from 66% in 2008 to 62.9% in 2014. Even turning this around slightly would increase employment growth above the 1% figure coming from population growth alone.
Although productivity growth has hovered around 1% for the past five years, this is less than half of the 2.5% average over the past 20 years.
Given the strong headwinds of globalization and ever new technology affecting the U.S. economy, we especially need new policies such as:
Fundamental tax reform directed at increasing the incentives for work and driving investment in productive assets.
Regulatory reform that balances economic benefits and costs (e.g. lightening the burdens of Obamacare and Dodd-Frank).
Trade agreements to break down barriers to open global markets.
Education policies to prepare all young people for productive careers.
In other words, rather than accepting our current situation as “the new normal” or as unalterable “secular stagnation,” we need to “give growth a chance”!
‘Secular Stagnation’ is the expression, made popular by the economist Larry Summers, to refer to the present time period, since the end of the Great Recession, with slow economic growth, high unemployment, stagnant middle-class wages and increasing inequality. It is to be contrasted with ‘The Great Moderation,’ from 1982 – 2007, with a rapidly growing economy, rising wages and stable prices. My last post, “Does ‘Middle Class Economics’ Really Work,” discusses President Obama’s attempt to appeal to middle-class families with policies such as:
Tax and regulatory provisions such as tax credits for childcare, college tuition, and second earners in two parent households; also requiring paid sick leave and a higher minimum wage.
Expanding access to community colleges to make workers more productive.
Increased infrastructure spending to boost employment.
The problem with this strategy is that it is much too weak to combat the huge headwinds opposing it. In addition to the well-known effects of globalization and technological advance, consider the demographical challenge described below:
OECD old age support ratio: the number of workers aged 20-64 relative to those aged over 65 As is very clear from this chart, the demographics are just going to keep getting worse and worse and will be very bad indeed by 2050.
Here is a surprising quote from Mr. Summers: “To achieve growth of even 2 percent over the next decade, active support for demand will be necessary but not sufficient. Structural reform is essential to increase the productivity of both workers and capital, and to increase growth in the number of people able and willing to work productively. Infrastructure reform, policies to promote family-friendly work, support for exploitation of energy resources, and business tax reform become ever more important policy imperatives.”
I would add several additional policy changes which would speed up change in this direction:
Reform (but not repeal!) the Affordable Care Act by eliminating all mandates. This would incentivize businesses to move part-time employees to full time. Tax credits and subsidies provide enough incentive for individuals to become insured.
Regulatory reform to make it easier to start a new business.
Raise the age limits for both Social Security and Medicare to encourage people to work longer.
Reform disability insurance to make it more difficult to be declared disabled.
Tighten up welfare requirements to require all able-bodied adult recipients without dependents to work.
Reform immigration with guest-worker visas for needed foreign workers.
We need to get serious about boosting our labor participation rate in order to grow the economy faster. Happy talk about ‘middle class economics’ will simply not do the trick!