One problem until now with the Obamacrat/left-liberal/progressive obsession with income inequality is that it all seemed terribly off point. Research suggests weak to zero linkage between inequality and economic growth, and between inequality economic mobility.
But former Obama/Clinton economist Larry Summers is doing his best to unite these various strands with his secular stagnation thesis: without continual fiscal or monetary stimulus, the US economy will continue to suffer from a chronic shortfall of demand. But more deficit spending is the better response given (a) the risk of bubbles from loose money, (b) the need for better infrastructure, (c) the low level of interest rates.
And what is causing the demand shortfall? Annie Lowrey of The New York Times is on the case:
I asked Mr. Summers what was behind secular stagnation, and he said he was still thinking through all of its causes. But globalization, automation, income inequality and changes in corporate finance might be important factors, he said. Income is now more concentrated in the hands of the rich. Those well-off households tend to save and invest higher proportions of their earnings than middle-class or low-income families do. That might mean, on aggregate, less spending and less demand across the economy for a given level of income.
There you go. Income inequality might be a key factor, maybe the primary factor, in America’s economic troubles, both pre-and-post Great Recession. Well, that and too little “public investment.” All and all, a comforting thesis for folks already tilted toward a policy mix of higher taxes and more spending.
But that last bit aside, is Summers correct? Embedded in his thesis are assumptions about the efficacy and impact of monetary policy, the nature of the Great Recession and Not-So-Great Recovery, and the willingness of policymakers to permit higher inflation. Again, here is Goldman Sachs’ take:
We agree that the real interest rate that would have been needed to achieve full employment has been deeply negative in recent years. In our view, policymakers would have achieved more desirable results if they had steered a more expansionary—or in the case of fiscal policy, less contractionary—course. Nevertheless, our view of the recent weakness is more cyclical than secular. The slow rate of recovery in recent years is roughly in line with the performance of other economies following major financial crises, as shown by Reinhart and Rogoff, and the reasons for the weakness in aggregate demand over the last few years have now begun to diminish.
Goldman, no surprise, sees economic acceleration coming. We’ll see. But I would really stress what I view as Summers’ big mistake on monetary policy. Ryan Avent:
Back in August, another eminent economist, Robert Hall of Stanford University, contributed a paper on the zero lower bound to the Kansas City Fed’s Jackon Hole conference, in which he estimated that the market-clearing real rate of interest is -4%. Now again, just why the real, natural rate of interest is currently -4% is an interesting question, but it’s irrelevant to the challenge of closing the output gap. All that matters there is that expected inflation is between 1% and 2% instead of near 4%. That’s the problem; that’s what’s keeping tens of millions of people out of work and hundreds of millions languishing in a perpetually weak economy: a couple of percentage points of inflation.
And central banks are entirely to blame for that.
The rich world’s biggest macroeconomic problem at the moment is a nominal problem and it is within central banks’ power to fix it. Now some will argue that because of the zero lower bound central banks lack sufficient policy traction to raise inflation. I don’t believe that. … At no point has the Fed done what its own chair reckoned Japan needed to do, at a minimum, to escape its own doldrums: set an inflation target of 3% or 4%.
If you accept the secular stagnation thesis, I think you also need to contend with Avent’s point. And I do not believe Summers adequately has.
Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.