Modern models please
As the Great Stagnation stretches out into the indefinite future, the level of GDP and the growth rate are widely judged to be too low. Voters are unhappy and the debate on how to respond is loud but inconclusive. What is the right mix of stimulus, austerity, structural changes and monetary policy? Something better is possible. Here are five simple rules for a more productive dialogue.
Rule One. Worry less. GDP in all but the most damaged developed economies is roughly as high now as five years ago. Growth has been lost, but that is a lesser problem than lost output. Although unemployment is a more serious issue, and there are a few very troubling instances, the joblessness is high rather than disastrous.
Rule Two. Forget about the Great Depression. It seems that many economists, from Ben Bernanke of the U.S. Federal Reserve downwards, think that the prime goal of current policy is to avoid repeating the mistakes that were made in the 1930s.
There is good news here. The financial crisis of 2008 did not lead to another slump of 1930s proportions, in part because the authorities avoided making the great mistake of the Great Depression – that is, allowing banks to fall down one after another like dominos. But there is little left to be learned. The changes in the last 80 years have been so great – in the size of the economy, the role of government, the position of the service sector, the level of tariffs and the organising principles of the financial and monetary systems – that distant historical comparisons are basically fanciful. Far too much intellectual energy is spent discussing what caused, prolonged and cured the sharp economic decline seen in the decade prior to World War Two.
Rule Three. Remember that different countries have different problems. Fans of both stimulus and austerity often seem to think their chosen remedy is a panacea for any country with economic problems.
It isn’t like that. The best remedies for Greek and Spanish declines, which came after massive foreign credit disappeared, are quite different from those needed in the United States and UK, where the financial fall-off was primarily domestic. Economic weakness anywhere reflects a collection of specific problems, ranging from demographic trends to punitive taxes on entry-level jobs.
Rule Four. Don’t make assumptions about the output gap. Back in the Great Depression, American farmers left fields untilled while American families went hungry. There was a clear output gap – actual consumption was less than desired consumption and possible production. Government action probably helped close that gap. The current situation is much harder to comprehend. Production may be unnecessarily low these days, but pre-crisis production may actually have been unsustainably high.
Take U.S. car and light truck sales. At the peak sales level in the years before the 2008 crisis, 5.9 percent of Americans had acquired a new vehicle in the previous 12 months. At the peak of recession it fell as low as 3.4 percent and the most recent reading was 4.7 percent. Maybe the government should sponsor a car-buying programme to increase production by 30 percent, enough to restore the pre-crisis level. But maybe the car-gap does not exist. After all, cars last longer than they used to, while driving declines with age and Americans are getting older.
Rule Five. Know the limitations. Few, if any, politicians, central bankers, regulators or big name commentators predicted the financial crisis. Though few will admit as much, no one knows how to end the current stagnation either.
Without arrogance, the policy debate could be more productive. Intellectual humility might open more minds to experiments which so many people now reject. Why not talk about direct government job creation, explicit monetary financing of fiscal deficits or significantly higher inflation targets? Or the panoply of other unconventional measures that lead to such vehement objections? There is much more to be learned from trying something new than from arguing about the distant past or screaming half-truths about the present.