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!
I have a good impression of Ben Bernanke, chair of the Federal Reserve from 2006-2014. Partly because he comes across as being both competent and honest and partly because Sheila Bair, chair of the Federal Deposit Insurance Corporation from 2006-2011, and whom I greatly admire, gives him high marks in her book, “Bull by the Horns,” about the financial crisis. Mr. Bernanke has an excellent Op Ed in yesterday’s Wall Street Journal, “How the Fed Saved the Economy,” clearly describing what the Federal Reserve both can and can’t do. What it can do is:
Make recessions less severe. The unemployment rate has been steadily dropping and now is apparently almost back to normal at 5.1% even though the relatively low labor-force participation rate and lack of wage pressure indicate remaining weakness.
Keep inflation low and stable. The Fed’s expansionary monetary policy has helped bring down unemployment without igniting inflation whose underlying rate is currently only 1.5%.
Mr. Bernanke states that “the Fed has little or no control over long-term economic fundamentals – the skills of the workforce, the energy and vision of entrepreneurs, and the pace at which new technologies are developed and adapted for commercial use.” He goes on to say that “further economic growth will have to come from the supply-side, primarily from increases in productivity. … Fiscal-policy makers in Congress need to step up” by adopting policies to:
Improve worker skills. (how about immigration reform, better vocational education, reforming SSDI and expanding the EITC to boost incentives to work)
Foster capital investment. (how about both individual and corporate tax reform and relaxing Dodd-Frank regulations on main street banks)
Support research and development. (how about making life easier for entrepreneurs with fewer regulations)
Mr. Bernanke has a very good handle on our current financial situation. The Federal Reserve has done and is doing its job. It’s time (long past time!) for fiscal policy makers (i.e. Congress and the President) to adopt policies, such as above, to speed up economic growth.
The financial crisis of 2008 was the biggest shock to our financial system since the Great Depression of the 1930s. It caused a deep recession from which we are still recovering. To aid the recovery the Federal Reserve launched an unprecedented expansion of the money supply, referred to as quantitative easing, as well as keeping short term interest rates near zero. As explained by James Rickards, a portfolio manager at West Shore Group, in his new book, “The Death of Money, the coming collapse of the international monetary system,” such a severe recession would normally have caused a corrective period of deflation. Quantitative easing has warded off deflation and, so far, without igniting inflation. We are now in a catch-22 situation. Congress could and should adopt several policy changes to speed up the recovery as I described several days ago in “The Federal Reserve Cannot Revive the Economy by Itself.” But, if and when the economy does start growing faster, it will require great skill by the Fed to exit from its current policies without harm. If it contracts the money supply too quickly, it risks a sharp rise in interest rates. If it contracts the money supply too slowly, it risks a sharp rise in inflation. Mr. Rickards doubts that the Fed will be able to accomplish this fine tuning without another major crisis. Here are his Seven Signs of what to look for:
The price of gold ($1300 per ounce today). A rapid rise to $2500 will anticipate inflation. A rapid decrease to $800 signals severe deflation.
Gold’s continued acquisition by Central Banks. Large purchases by China, for example, will announce inflation.
IMF governance reforms, e.g. towards more voting power for China, will be an inflation warning.
The failure of regulatory reform, i.e. reinstatement of Glass-Steagall in addition to the Volcker Rule, will increase the chances of systemic failure.
System crashes, resulting from high-speed, highly automated, high volume trading. An increasing tempo of such events will cause disequilibrium which could close markets.
The end of QE, could give deflation a second wind and lead to a new round of QE.
A Chinese collapse (predicted by Rickards), will lead first to deflation and then inflation.
We all hope that the Federal Reserve can steer clear of a new, and much deeper, financial crisis. But it doesn’t hurt to have guideposts and Mr. Rickards knows what he’s talking about.
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe.”
Ludwig von Mises, Austrian economist, 1881 – 1973
The economist/investor John Mauldin writes a weekly newsletter, “Thoughts from the Front Line” (http://d21uq3hx4esec9.cloudfront.net/uploads/pdf/140426_TFTF2.pdf) which offers good general insight. In the latest issue Mr. Mauldin writes “For all intents and purposes we have adopted a trickle-down monetary policy, one which manifestly does not work and has served only to enrich financial institutions and the already wealthy. Now I admit that I benefit from that, but it’s a false type of enrichment, since it has come at the expense of the general economy, which is where true wealth is created.” Mr. Mauldin also quotes the economist William White, “When you talk about crisis resolution, it’s about attacking the fundamental problems that got you into trouble in the first place. And the fundamental problem we are still facing is excessive debt. Not excessive public debt, mind you, but excessive debt in the private and public sectors. … With ultra-loose monetary policy, governments have no incentive to act. But if we don’t deal with this now, we will be in worse shape than before.”
What then should government do? The best single thing is to develop a concentrated focus on boosting the economy. This would put millions of people back to work and raise salaries for the entire workforce. Tax revenue would rise and both public and private debt would be paid down more quickly.
The way to do this is with fundamental, broad-based tax reform. This means lowering tax rates for both individuals and corporations, paid for by closing loopholes and shrinking deductions. This would have the effect of taking from the rich and giving to the poor, i.e. putting more money in the hands of those who are most likely to spend it, thereby creating more demand leading to faster economic growth.
It’s not that hard to figure out!
“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!
In yesterday’s Wall Street Journal, Mortimer Zuckerman, the Chairman of U.S. News and World Report, writes that “A Jobless Recovery is a Phony Recovery”. He points out that counting the people who want full time work and can’t get it, as well as those who have stopped looking, the real unemployment rate is really 14.3% rather than the officially reported 7.6%. Enormous fiscal (deficit spending) and monetary (quantitative easing) stimulus has been able to stimulate an average growth rate of only 2% for the past four years since the recession ended in June 2009. During these last four years the civilian workforce-participation rate has actually declined from 65.7% to 63.5% which has never happened before in an even slowly expanding “recovery” like we have at the present time.
Keynesians and Obama Administration apologists say that we need even more fiscal stimulus (we can worry about deficits and debt later); tax reform won’t help because tax rates are already low; massive new regulations (ObamaCare, Dodd-Frank financial regulations, EPA environmental regulations) are so important that they override negative economic effects; etc. At some point, the sooner the better, we need to recognize that current policies are not working and are, in fact, retarding the recovery from the recession.
Tax reform is the biggest single change which would help. Removing deductions and tax preferences, and replacing them with lower tax rates, would give a big boost to investment and entrepreneurship, and thereby be a huge stimulus to the economy. This includes eliminating the tax exemption for employer provided health insurance. Combining this reform with repeal of ObamaCare’s Employer Mandate would also lead to getting the cost of healthcare under much better control. The overall cost of healthcare, 18% of the American economy and growing, is a huge long term burden and must be turned around.
The massive complexity of Dodd-Frank is a huge burden on the financial industry. Preventing banks from becoming “too big to fail” can be accomplished by having more adequate reserve requirements along with sufficient default and liquidity insurance pools, along with otherwise minimal regulation.
Only more private investment and risk taking can make the economy grow faster and bring down the unemployment rate. The sooner our national policy makers (and the voters who elect them!) figure this out and act accordingly, the sooner that our economy will truly begin to recover from the Great Recession.
In today’s Wall Street Journal the economist Alan Blinder writes, “The Economy Needs More Spending Now”, that the tax hikes and spending cuts agreed to in January and before are reducing GDP growth by 1.5% – 2% annually. Mr. Blinder claims that it would be easy to design a new fiscal stimulus package that adds 2% to GDP per year as long as it lasts. He also claims that a fundamental change like tax reform might only add a much smaller .2% to GDP per year although this much smaller annual effect would repeat indefinitely and therefore eventually amount to a large cumulative effect. This is a sensible argument as far as it goes but is incomplete.
In the last five years there has been almost $6 trillion in (deficit) stimulus spending, coupled with a $3 trillion quantitative easing program by the Federal Reserve. This represents an unprecedented fiscal and monetary stimulus to the economy by the federal government. And the result has been a tepid although steady 2% annual growth in GDP, much slower than usually follows a recession.
After all of this enormous stimulus, which is having only a meager effect, what makes more sense: to try even more stimulus or to try something different? What else is there to try? Immigration reform will boost the economy by drawing our 11,000,000 illegal immigrants into the main stream economy. Note that citizenship (amnesty) is not required to accomplish this, only legal status. Also, requiring many people receiving welfare (food stamps, disability benefits, etc.) to work would boost the economy by increasing the size of the labor force.
Broad based tax reform, greatly curtailing most, if not all, tax preferences, would be so attractive that it should not be put on a back burner, as Mr. Blinder suggests. In fact, completely repealing the ACA’s Employer Mandate, now that it’s been postponed for a year, would give a big boost to many medium sized companies for which required health insurance is a big impediment to growth.
The point is that there are many ways to boost the economy besides even more artificial deficit stimulus, whose effect would be at most temporary anyway, as Mr. Blinder suggests. It really is important to shrink our still very large annual deficits down to zero fairly quickly so that we stop adding to the huge burden which we have already placed on future generations. In other words, we can likely have stronger economic growth and fiscal restraint at the same time, the best of all possible worlds!
The New York Times’ Eduardo Porter has a column in yesterday’s paper “Making the Case for a Rise in Inflation”, arguing that a 4% inflation rate, for example, would be a better target rate for the Federal Reserve than its present 2% target rate. The idea is that higher inflation would lessen the value of a dollar, thereby eating away at our $12 trillion in public debt (on which we pay interest). A lower value of the dollar would also boost the economy by making exports less expensive. Higher inflation would likewise encourage consumers to spend more because the value of the dollar is decreasing more rapidly.
Mr. Porter does point out that there would be opposition to any policy of purposely letting inflation go up. The best known Fed Chair in recent years, Paul Volcker, says that “All experience amply demonstrates that inflation, when fairly and deliberately started, is hard to control and reverse”.
The biggest problem, though, is the risky procedure of trying to boost the economy with monetary policy (quantitative easing, QE1, QE2 and QE3) rather than using fiscal policy (tax reform and deregulation). The creation of an enormous amount of new money in a slow recovery creates huge upward pressure on inflation. The economy is slowly improving on its own accord. Very soon (in the next few years) the Fed will have to perform the difficult function of withdrawing money from the system fast enough to avoid inflation and, at the same time, slow enough, to keep interest rates from skyrocketing. So the question is, will the Fed be able to simultaneously keep both inflation and interest rates under some kind of control?
For sure we don’t want to make its job more difficult by pushing inflation any higher than necessary at the present time!
In a New York Times column on May 3, 2013, “Not Enough Inflation”, Paul Krugman writes that since we are now in a liquidity trap, where business is sitting on hoards of cash, what we need is more inflation. A higher rate of inflation would encourage more borrowing and spending and make it easier to pay down debt. Inflation is low because of the economy’s persistent weakness which prevents workers from bargaining for wage increases and forces business to hold down price increases. He goes on to say that what we also need right now is “more stimulus, monetary and fiscal, to reduce unemployment” and that “the response from people who consider themselves wise is always that we should focus on the long run, not on short-run fixes”. I think that Mr. Krugman has overstated his case as he so often does.
On May 4 the NYT “Off the Charts” columnist Floyd Norris shows that “Business Investment Rebounds Even as Recovery Drags”. He looks at data for our four most recent recessions which shows that while consumer spending is growing slowly in our current recovery, and government spending (federal, state and local) is way down, business investment has been quite strong. This is especially significant because the Stanford economist, John Taylor, has pointed out the amazingly strong inverse correlation between business investment and the unemployment rate. (See also his more recent blog on February 4, 2013.) This is a strong indication that the unemployment rate will continue to drop and perhaps even more quickly in coming months.
In summary: business investment in growing robustly, consumer spending is growing steadily, and quantitative easing (monetary policy) is just about maxed out. Government spending is down but this is primarily because state and local governments have to balance their budgets. So there is really only one policy lever left to further stimulate the economy, i.e. federal spending.
However this is where the long run matters at least as much as the short run. With the national (public) debt currently at 76% of GDP and growing, it is simply too risky to let it go much higher. In fact it is only prudent to begin reducing it as soon as possible. Absent an unforeseen national emergency this must be our first priority.