Is this as good as it gets? America’s almost-Fed chairman Larry Summers says it might be. In a recent IMF speech that’s the buzz of the economics world, Summers said advanced economies, including the United States, risk falling into a Japanese-style, permanent malaise. The Great Slump That Never Ends. Interest rates never normalize and inflation stays low while employment and wage growth stay weak. Summers speculates that the natural interest rate “consistent with full employment” fell “to negative 2% or negative 3% sometime in the middle of the last decade.”
But conventional monetary policy can’t push rates that low. The dreaded Zero Lower Bound. Thus, Summers concludes, “We may well need, in the years ahead, to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back, below their potential.”
The argument is based on two observations: first, even before the Great Recession and Financial Crisis, US GDP output and job growth was mediocre despite the lending-mania that inflated the housing bubble. Summers: “Was there a great boom? … Somehow even a great bubble wasn’t enough to produce any excess in aggregate demand.”
Second, four years after the end of the panic, GDP remains far below its prerecession trend and the share of the US adult population with a job remains depressed. While the Great Recession is officially over, Summers paraphrases Yogi Berra: “It is not over until it is over.” And based on how the vast majority of Americans are doing, it isn’t over.
So that’s the diagnosis. What’s missing is the “why” and the “what next.” Summers doesn’t specify his answers to those questions, but his reference in the speech to economist Alvin “The American Keynes” Hansen may provide clue. In the late 1930s, Hansen worried that America would never really recover from the Great Depression and return to prosperity. He worried it faced “secular stagnation” — a phrase Summers embraces — due to declining population growth and slowing technology innovation. Boosting growth, he said, might require large, permanent budget deficits.
Summers might well see things the same way today as Hansen did then. As Paul Krugman points out, the population aged 18 to 64 is forecasted to barely grow the next decade. And Obama White House economists argued earlier this year that economic growth “is likely to be permanently slower … because of a slowdown in labor force growth initially due to the retirement of the post-World War II baby boom generation, and later due to a decline in the growth of the working age population.” What’s more, many economists today worry about a “great stagnation” for technology innovation, noting a productivity slowdown starting in the late 1970s.
But surely Summers couldn’t buy into Hansen’s solution — lots more government spending? Not with a $17 trillion US national debt?
He might. Economist and frequent Summers collaborator Brad DeLong has been writing on the same topic. In one recent blog post, DeLong asked, “So where is the demand to push the economy into a large boom going to come from?” He then shows a chart highlighting a decade-long decline in government purchases as a share of GDP. DeLong also thinks it’s likely that the US can just keeping borrowing and borrowing ”and never have to pay it back because the economy grows faster than interest accrues. In which case the U.S. government looks much more like the Renaissance Medici Bank–an organization you are happy to pay to keep your money safe, rather than a debtor from whom you demand a healthy return.” In other words, time for more fiscal stimulus.
Summers’s thesis deserves greater analysis — particularly his view of the prerecession 2000s economy — than I can provide a single blog post, but a few observations:
1. Regarding the problems of the ZLB, Summers is too dismissive of unconventional monetary policy, especially in conjunction with an expectation- altering move by the Fed to begin targeting the level of total spending, or nominal GDP, in the economy. While Summers says Fed bond buying can’t go on forever, quantitative easing has been rendered less effective that it could have been because of a lack of a NGDP level target. Monetary policy could be doing much more to help the economy reach its potential. If Summers thinks we need higher inflation to produce those negative interest rates and higher demand, there is good reason to believe the Fed and other central banks can provide it.
2. Not only was Hansen proven wrong by the postwar boom, but it is particularly notable that at the exact time he was worried about an innovation slowdown, the economy was going through an innovation boom. The productivity research of Alexander Field finds the years 1929 through 1941 were exceptionally innovative ones “with the consequence that a significant fraction of the productivity foundations of the postwar epoch were already in place before 1941.” We may well be going through a similar period right now that’s not being captured by current productivity metrics.
And AEI’s Stephen Oliner, a former Fed economist, writes in a recent paper that slower productivity growth is largely explained by reduced contributions from IT, after the tech boom from the mid-1990s to about 2004. But he also points out that chip innovation is continuing at a rapid pace, “raising the possibility of a second wave in the IT revolution [and] that the pace of labor productivity growth could rise to its long-run average of 2¼ percent or even above.” Of course, some economists like Tyler Cowen think the result of the innovation will mean vastly more income inequality and an extreme thinning of the US middle class.
3. If we are worried about slowing population growth and labor force supply — certainly a problem in Japan — then perhaps it is time to embrace higher immigration (with an emphasis on high skill), reduce the anti-child bias in tax policy, and reduce disincentives to work in our welfare policy, including Social Security.
4. Japan is combating its Lost Decade(s) with “three arrows”: easier monetary policy, fiscal stimulus, and regulatory reform. Maybe America needs three arrows of its own: NGDP level targeting (including a period of higher inflation), pro-labor force reform (immigration, fertility rates, work incentives — especially for long-term unemployed), and pro-innovation reform (education, tax policy, regulation, public investment). Summers diagnosis might be wrong, but we should assume it isn’t.