Avoiding A Global Recession: Let’s Add Another Locomotive to the DeLong Train
Brad DeLong has an interesting analogy for recent developments for the global macroeconomy:
Perhaps the best way to look at the situation is to recall that three locomotives have driven the world economy over the past 15 years. The first was heavy investment, centered in the United States, owing to the information technology revolution. The second was investment in buildings, once again centered in the US, driven by the housing boom. The third was manufacturing investment elsewhere in the world – predominantly in Asia – as the US became the world economy’s importer of last resort. For 15 years, these three locomotives kept the world economy near full employment and growing rapidly. When the high-tech boom ended in 2000, the Federal Reserve orchestrated its replacement by the housing boom, while investment in Asia to supply the US market was chugging along at an increasing pace. Many today are complaining about Alan Greenspan’s monetary stewardship, which kept these three locomotives stoked: “serial bubble-blower” is the most polite phrase that I have heard. But would the world economy really be better off today under an alternative monetary policy that kept unemployment in America at an average rate of 7% rather than 5%? Would it really be better off today if some $300 billion per year of US demand for the manufactures of Europe, Asia, and Latin America had simply gone missing?
Not to interrupt Brad, but let’s note that he’s right about the recent – and in my view inappropriate – FED bashing. But let’s give the microphone back to Brad:
The first locomotive, however, ran out of fuel seven years ago, and there is no clear technology-driven alternative leading sector, like biotechnology, that can inspire similar exuberance, rational or otherwise. The second locomotive began sucking fumes two years ago, and is now coasting to a halt, which means that the third – the US as importer of last resort – is losing speed as well: the weak dollar accompanying the housing finance crash makes it unprofitable to export to the US. The world economy, as John Maynard Keynes put it 75 years ago, is developing magneto trouble. What it needs is a push – more aggregate demand. In the US, the weak dollar will be a powerful boost to net exports, and thus to aggregate demand. But, from the perspective of the world as a whole, net exports are a zero-sum game. So we will have to rely on other sources of aggregate demand.
While Brad is correct that expenditure-switching policies being a zero-sum game for global demand (assuming similar marginal propensities to spend across nations) if some nations have more economic slack than others – expenditure-switching policies can complement the types of expenditure-adjusting policies that Brad advocates:
The first source is the government. Fiscal prudence is as important as ever over the medium and long term. But for the next three years, governments should lower taxes – especially for the poor, who are most likely to spend – and spend more. The second source is private investment. The world’s central banks are already cutting interest rates on safe assets, and will cut them more as the proximity and magnitude of the likely global slump becomes clear. But low interest rates are entirely compatible with stagnation or depression if risk premia remain large – as the world learned in the 1930’s, and as Japan relearned in the 1990’s. The most challenging task for governments is to boost the private sector’s effective risk-bearing capacity so that businesses have access to capital on terms that tempt them to expand.
Brad is a fellow (long-run) deficit hawk so to suggest temporary fiscal stimulus must mean he is really concerned about a lack of aggregate demand. Given the fact that I think his concern is well warranted, maybe it’s time for me to make my own small contribution. As you may recall, I’ve been concerned about the tax cut route having little bang for the buck:
Those who preach the Life Cycle Model (LCM) would tell us that that one-time rebates will be mostly saved with very little aggregate demand stimulus. In other words, a big impact on the current deficit but little impact on consumption demand just when we likely need it. There is a possible rebuttal to this LCM view that goes like this. Lower income households are likely liquidity constrained so a tax rebate is sort of like the loan they could not get from the bank. So if we target this temporary tax relief to lower income types, then maybe we will get a strong bang for the buck. But back to the politics where it has been standard operating procedure for the GOP to shift taxes onto the young by giving most of the tax breaks to rich older dudes. And these rich older dudes are not likely to be so liquidity constrained, which means the LCM view likely is valid if we let the GOP have its way. But isn’t this the real problem with the use of fiscal policy – partisan agendas tend to trump what most reasonable economists would consider the most effective means of handling our economic issues.
While Brad did stress that tax cuts be given to the poor, let me also suggest we consider another locomotive – public investment in things like schools, bridges, and better roads. We could accelerate this type of spending and yet promise to return to fiscal prudence in a few years.
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