January 22, 2018
In a Washington Post column this morning, Larry Summers rightly points out that there is little reason to believe that President Trump has much to do with the US economy’s relatively good performance over the last year. As he notes, most other major economies have seen even larger upturns relative to their predicted growth path.
In addition, it is worth noting that some of the uptick in the US may simply be due to the continuation of the Obama–Yellen recovery. As Jared Bernstein and I pointed out last month, there is reason to believe that the tightening of the labor market may lead to an uptick in productivity growth. There is some preliminary evidence that we are now on a trend of faster growth.
The place where I would differ with Summers is his dire warnings about the next recession, which surely will come at some point.
“If and when recession comes, the world will have much less room than usual to maneuver. From a narrow economic perspective, there will be much less room than the usual 500 basis points of space to bring down interest rates. There will also be much less space for fiscal expansions than there was when countries were less indebted.”
Summers is right that the Fed will again have to rely on unorthodox monetary policy, such as quantitative easing, to provide a boost in the next recession. (This is why many of us have argued for an inflation target higher than 2.0 percent.) However, it is not clear that there actually will be less space for fiscal expansion.
The limit for countries like the United States, which have their own currency, is the point at which spending overheats the economy and leads to inflation. Since the point of stimulus is to boost the economy out of a recession, there is no reason we would want to get to this point in any case.
Japan offers us a case study here, its debt-to-GDP ratio is 240 percent of GDP, almost two and a half times as much as ours. Nonetheless, its interest rate on long-term bonds is less than 0.1 percent and until recently investors were paying Japan for the opportunity to make these long-term loans. If we are really mired in a severe downturn, it’s hard to see why our situation would be any different from Japan’s. (Japan’s debt service burden is less than 1.0 percent of GDP. Ours was over 3.0 percent of GDP back in the early and mid-1990s.)
It is also worth bringing in the story of robots taking all our jobs. This is a story of a massive uptick in productivity growth. Perhaps we will even get back to the 3.0 percent rate of the long Golden Age from 1947 to 1973. Of course, that was a period of rapid wage growth and low unemployment. It’s possible that we won’t see the same wage growth this time due to weaker unions, the decision to expose less-educated workers to competition with low paid workers in the developing world, and more protectionism in the form of longer and stronger patent and copyright protection.
However, in this case, there would be no reason for the government not to make up the lost demand with larger budget deficits. If we don’t run large deficits in this scenario the obstacle will be political, not economic.
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