It is widely recognized and deplored, see here and here, that economic growth in the U.S. has been very slow, averaging only 2% per year, since the end of the Great Recession in June 2009.
The Federal Reserve has taken unprecedented steps to limit the severity of the recession by holding down both short term and long term interest rates. But these efforts are only partially working and are, unfortunately, having a number of negative effects as well.
It also has been made quite clear that the problem is supply side and not demand side. This is because, on the one hand, wages are beginning to rise more quickly and consumers are spending more money but, on the other hand, business investment is shrinking which is leading to slow productivity growth. The American Enterprise Institute’s James Pethoukoukis has just provided new data on the current weakness of business investment as illustrated in the above chart. Furthermore he quotes the economist, Robert Gordon, who has clearly described the many headwinds holding back the U.S. economy to the effect that:
“The American tax code exerts a downward pressure on capital formation and therefore on economic growth. It is now 30 years since the passage of comprehensive federal tax reform in the U.S. In the intervening years, nearly every developed country has reformed its tax codes to make them more competitive than that of America. Meanwhile the U.S. has allowed its tax code to atrophy.”
Conclusion. Yes, economic growth can be speeded up. But monetary policy won’t do the trick. Congress must intervene with the right changes to fiscal policy, i.e. lowering tax rates for both individuals and corporations, paid for by closing loopholes and shrinking deductions.
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!
“Consider the following scenario. You are an airline pilot charged with flying a planeload of passengers across the Atlantic. You are offered the choice of two different aircraft. The first aircraft has been prepared by chief engineer Keynes and the second by chief engineer Hayek.
You have to choose which plane to use, so naturally you ask the advice of the two engineers. Keynes urges you to use his aircraft, offering a convincing explanation of why Hayek’s plane will crash on take-off. Hayek urges you to use his aircraft, offering an equally convincing explanation of why Keynes’s plane will crash on landing. At loss as to which plane to choose, you seek the advice of two leading independent experts – Karl Marx and Adam Smith. Marx assures you that it does not matter which aircraft you choose as both will inevitably suffer catastrophic failure. Similarly, Smith also reassures you that it does not matter which aircraft you choose, as long as you allow your chosen craft to fly itself.”
Thus begins a fascinating new book, “Money, Blood and Revolution: How Darwin and the doctor of King Charles I could turn economics into a true science,” by the fund manager and economist, George Cooper. Mr. Cooper sets up a circulatory model of democratic capitalism whereby rent, interest payments and profits flow from low income people at the bottom of the pyramid to the wealthy at the top. And then tax revenue (collected mostly from the wealthy) is redistributed downward in the form of government programs.
According to Mr. Cooper, the financial crisis was caused by a combination of lax regulation and excessive credit and monetary stimulus. The question is what to do about it. Mr. Cooper says:
Stop adding to the problem. High student debt and high mortgage debt are still being supported by government programs.
Change the course of the monetary river. Quantitative easing does not work because it just puts money into the hands of the wealthy and they have no incentive to spend it.
Change the course of the fiscal river. Instead put money into the hands of the people at the bottom of the pyramid with expanded government spending on infrastructure (paid for by taxing the wealthy).
Without endorsing all of Mr. Cooper’s suggestions, he nevertheless has many good ones and expresses them in a highly entertaining style!
On page nine of today’s New York Times is published a full page letter to Congress and President Obama, “Enact The Inform Act”, signed by over one thousand economists as well as former government officials. It would require “the Congressional Budget Office, the Government Accountability Office and the Office of Management and Budget to do fiscal gap and generational accounting on an annual basis to assess the sustainability of fiscal policy and measure, on a comprehensive basis, the fiscal obligations facing our children and future generations.
“Unlike the measurement of the official federal debt, fiscal gap and generational accounting are comprehensive. They leave nothing off the books, be it defense spending, Medicare expenditures, or the profits of the Federal Reserve, in assessing the sustainability of fiscal policy and the size of the fiscal bills being left to our own children.”
The INFORM Act is sponsored by a nonpartisan and millennial driven organization which goes by the name, The Can Kicks Back . This is very significant because it is precisely the younger generation of Americans who should be most concerned about the fiscal irresponsibility of so many of our national leaders. They are the ones who will be stuck with the huge national debt which is being generated by the profligacy of federal spending and also the ones who may have their own retirement benefits greatly curtailed because of it.
Young people should be especially incensed by such irresponsible behavior which will affect them so greatly. We should support their efforts to turn around this ugly situation!
Today’s Omaha World Herald reprints the article “Get-nothing-done Congress is disrespectful to democracy” by the Baltimore Sun writer, Andrew Yarrow. Mr. Yarrow says that “the 112th Congress, which ended in 2012, passed fewer bills than any Congress in recent memory, and the current 113th Congress is on track to do just as badly. … What Congress does do often seems patently ridiculous. … We need to … ramp up public pressure to get something done, rather than just fight.”
But is the problem just to do something, anything, or is it rather to do something worthwhile? And what if there is a fundamental disagreement, as there is today, about what is worthwhile? One party thinks that the way to boost the economy and speed up the recovery is to increase artificial stimulus (government spending) and to pay for it by raising taxes on the rich. The other party is appalled by the $6 trillion in deficit spending racked up so far by the current administration and wants to slam on the brakes. Each side is working as hard as it can to prevail, especially by discrediting and embarrassing the other side. How do you resolve a dispute like this?
There is really only one person who has the clout and visibility to get this done and that is the President. But when the President is the divider-in-chief, spending much of his time and effort proposing unsound economic and fiscal policies, intended primarily for short term political gain, what is the other party supposed to do? Acquiesce by passing new laws that will just make things worse? Or by standing firm on principle and hoping that the general public will be able to understand and appreciate its opposition to bad policies?
This is the situation which we are currently in. It makes for a difficult and unpleasant time. The economy is slowly recovering from the Great Recession on its own. Let’s hope that this trend continues and that we can muddle through our present political predicament.