Tyler Cowan argued that a recent interview with Larry Summers was the best single statement on the topic of the current stagnation. Summers correctly notes that the US economy is 10 per cent below where we (i.e. he) thought it would be in 2007. He also correctly argues that the demise can be traced back a dozen years.
But his analysis goes downhill from there.
First, he argues that the housing bubble was beneficial because it boosted GDP by 2-3 per cent and raised consumption levels; the failings were that it was insufficient to permanently kick-start the economy. In fact the housing bubble and consumption boom sucked income from productive investment and, like all such government induced stimuli, lowered the underlying productivity growth of the US economy.
Secondly, he argues that part of the reason for the stagnation was some countries’ “large-scale reserve accumulation”. While it is better all-round if exchange rates are not manipulated by governments, it must be remembered that current account surpluses are balanced by capital account outflows. That means a flow of resources to the counties operating the current account deficits, resources which add to the deficit countries’ investable funds, if they are operating their economies wisely. Of course, if the recipient countries are not well managed, the inflow will simply be used to increase their levels of consumption in a way that has been observed and that cannot be sustained.
Thirdly, he laments what he sees as a fact that a greater inequality in earnings has taken place in the US and that the poor save far less of their income than the rich bringing about deficient consumption. He seems to be unaware why the poor save so little – it cannot be because they need all their income as the Chinese, who are very much poorer than Americans, save 50 per cent of their national income compared to 17 per cent in the US. Again, he sees the route to growth as consumption expenditure with no regard to the fact that this is made possible only by higher levels of production, a key factor in which is higher productive (market-driven) investment.
He poses three possible solutions. The first is to do nothing and let the economy cure itself. He says, seemingly unaware of the fact that the US budget is covering only two thirds of government spending and the massive infusion of credit through the Fed activities, that this has been the approach!
His second strategy is to ensure interest rates fall to zero – presumably with negative interest rates on government bills. He also, confusingly, says this strategy has been followed and considers it preferable to the do-nothing approach but considers there is a risk because investments will have been funded at such low rates. He also considers this is a poor strategy since driving down interest rates inflates asset values to the benefit of the rich.
His solution is government investment in infrastructure, energy regulations to stimulate demand, more funding of R&D and “a concerted effort to raise exports”. At least that approach addresses the supply side. But it does so in a winner-picking statist way and without any suggestion that other areas of spending are to be reduced to make room for the new programs.
Maybe the world dodged a bullet in avoiding having Summers as the Chairman of the Fed, but then again Yellin may be worse and Bernanke was no better.