california dreaming

audio  This blog post accompanies the SDPR Morning Macro segment that airs on Monday, January 13.

Earlier this month, the American Economic Association (AEA) held its annual meeting—a three-day conference during which hundreds of speakers present their detailed economic analyses of myriad social science issues.  Each year, the AEA annual meeting is held in conjunction with 61 other affiliated social-science associations; the affiliation is known as the Allied Social Science Association, or ASSA for short.  The meeting includes an enormous job fair, where institutions in and outside academe and job candidates meet, and several special events, including the presidential address—this year presented by outgoing (2019) AEA president, Ben Bernanke, former chair of the Federal Reserve System.  (The incoming AEA president is Janet Yellen, who, incidentally, followed Bernanke as chair of the Federal Reserve System—just a coincidence.)

The AEA was established in 1885.  It is a non-profit, non-partisan, scholarly association whose purpose is to encourage, discuss, and publish research in economics.  Today, the association includes more than 20,000 members—yes, including me—from academe, business, and government.  The AEA supports established and aspiring economists in several ways.  In addition to the its annual meeting, complete with the job fair, the AEA fosters several scholarly (journal) outlets for economic research, EconLit (a database of scholarly research in economics available, incidentally, through SDSU’s Briggs Library), and hundreds of other resources.

This year, the AEA held its annual meeting (on January 3 – 5) in San Diego, California; roughly 13,450 fellow AEA members and I attended—I know, that’s a lot of economists in one place, one very beautiful, warm, and sunny place.  I attended several sessions; most though not all of the sessions I chose were on the subject of macroeconomics.  Of course, no two attendees would share the same experiences or takeaways from the annual meeting.  Nevertheless, I thought sharing my takeaways—what macroeconomists were talking and dreaming about in California—would be of interest to Morning Macro devotees.  I settled on three big themes: macroeconomic stagnation, fiscal policy, and the federal debt.  Next, I offer some context for each theme under a heading that links to the corresponding AEA annual-meeting session site, where you can find information on the session’s speakers, their affiliations, the titles of their papers, and so forth.

The United States Economy: Growth, Stagnation or New Financial Crisis

In his presidential address delivered at the 51st annual meeting of the American Economic Association (Detroit, Michigan, December 28, 1938), Alvin Hansen spoke on “secular stagnation—sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment” Hansen (1939, 4).  Hansen titled his talk (and subsequent article in the March 1938 edition of the American Economic Review), “Economic progress and declining population growth.”  The timing of this presidential address is, of course, noteworthy: in the decade preceding the address, the United States economy suffered the Great Depression (August 1929 — March 1933) and, soon thereafter, a recession (May 1937 — June 1938).  At the time of the address, the economy had been expanding for only six months, according to the National Bureau of Economic Research.

No wonder Hansen was concerned about secular stagnation.

According to Hansen, the principal sources of economic progress—as opposed to stagnation—are threefold: “(a) inventions, (b) the discovery and development of new territory and new resources, and (c) the growth of population.  Each of these in turn, severally and in combination, has opened investment outlets and caused a rapid growth of capital formation” (Hansen 1939, 3).  Essentially, Hansen argues that these three principal sources generate economic progress through investments in capital—think, the accumulation of machinery, equipment, structures, and intellectual property products—which Hansen refers to as capital formation.  Neither the discovery and development of new territory and new resources or changes in the growth of the population are likely to materially change the path of the current United States economy.  Thus, when contemporary economists discuss Hansen’s secular stagnation conjecture, we focus almost exclusively on inventions and capital formation.

As for macroeconomic policy interventions, Hansen reasoned—presciently, some might say—that the ability of monetary policy, by way of changes in interest rates, to stimulate capital formation was limited; here Hansen (1938, 5) writes:

Less agreement can be claimed for the role played by the rate of interest on the volume of investment. Yet few there are who believe that in a period of investment stagnation an abundance of loanable funds at low rates of interest is alone adequate to produce a vigorous flow of real investment.  I am increasingly impressed with the analysis made by Wicksell who stressed the prospective rate of profit on new investment as the active, dominant, and controlling factor, and who viewed the rate of interest as a passive factor, lagging behind the profit rate.  This view is moreover in accord with competent business judgment.  It is true that it is necessary to look beyond the mere cost of interest charges to the indirect effect of the interest rate structure upon business expectations.  Yet all in all, I venture to assert that the role of the rate of interest as a determinant of investment has occupied a place larger than it deserves in our thinking.  If this be granted, we are forced to regard the factors which underlie economic progress as the dominant determinants of investment and employment.

Put differently, then, profitable opportunities, stimulated by invention (itself potentially a function of the capital stock), drive investment expenditure and, in doing so, economic progress.  Or, in modern parlance, expansionary monetary policy, which lowers interest rates with the intent of stimulating investment expenditures, is a bit like pushing on a string.  Finally, Hansen recognized the potential for expansionary fiscal policy to stimulate aggregate demand, including demand in the form of consumption and investment expenditures.  Nevertheless, Hansen had reservations.  He reasoned—again, presciently, some might say—that expansionary fiscal policy could disrupt private enterprise, create unsustainable public-debt burdens, and crowd out private investment; here Hansen (1938, 12) writes:

Consumption may be strengthened by the relief from taxes which drain off a stream of income which otherwise would flow into consumption channels.  Public investment may usefully be made in human and natural resources and in consumers’ capital goods of a collective character designed to serve the physical, recreational and cultural needs of the community as a whole.  But we cannot afford to be blind to the unmistakable fact that a solution along these lines raises serious problems of economic workability and political administration. How far such a program, whether financed by taxation or by borrowing, can be carried out without adversely affecting the system of free enterprise is a problem with which economists, I predict, will have to wrestle in the future far more intensely than in the past.  Can a rising public debt owned internally be serviced by a scheme of taxation which will not adversely affect the marginal return on new investment or the marginal cost of borrowing?  Can any tax system, designed to increase the propensity to consume by means of a drastic change in income distribution, be devised which will not progressively encroach on private investment?

So, reservations aside, expansionary fiscal policy, through tax cuts or increases in government spending could stimulate aggregate demand and, potentially, alleviate secular stagnation, particularly if the fiscal-policy induced expenditures were directed toward human-, physical-, and social-capital goods.

Okay, so why are economists talking about Alvin Hansen and secular stagnation?

Currently, the United States economy is in the expansion phase of its business cycle.  Indeed, this expansion is the longest in Post-WWII U.S. history; but, it is also the weakest expansion in Post-WWII U.S. history.  (For more on business cycles, see the Morning Macro segment, “Growing Old(er).”)  And, of course, the current expansion was preceded by a severe financial crisis that induced the Great Recession, the most-severe deterioration in economic activity since the Great Depression; though the Great Depression was an order of magnitude worse than the Great Recession. To some economists, including former Secretary of the Treasury, Larry Summers, the United States appears to be in secular stagnation much like Hansen described; growth in output and the rate of inflation are low, the outcomes of low aggregate demand perhaps.  (Though, unemployment is not high, as it was when Hansen spoke of secular stagnation.)

Summers and other economists who share his view argue that, despite Hansen’s reservations regarding the disruptions to free markets, budgetary challenges, and crowding out of private investment that fiscal policy could invite, public investment is warranted at this time.  In his remarks during this AEA session, Summers quipped, “Risks that we could excessively publicly invest are small.”  To be sure, net private investment and net public investment—both net of depreciation—have fallen relative to GDP since 1950, the subject of our next Morning Macro segment.  In any case, plenty of economists disagree with Summers, reasoning instead that the growth in the potential output of the economy has stagnated and, thus, aggregate-demand-side policies are inappropriate.

Countercyclical Fiscal Policy

At least since the Great Recession, in their search for policies intended to shape the general features of the economy, macroeconomists and policymakers have turned almost exclusively to monetary policy—managing the money supply and interest rates in order to achieve macroeconomic objectives, such as low and stable inflation or full employment.  The institution responsible for implementing monetary policy in the United States is the Federal Reserve System, or Fed for short, the nation’s central banking system.  (For more on the institutional structure of the Fed and its monetary policy tools, see the Morning Macro segment, “Fed Up.”)  Anyone who even casually reads or listens to discussions surrounding macroeconomic policy is often reminded of the Fed; it’s front-page news almost every day.

Nevertheless, since the Great Recession, interest rates have remained relatively low; the federal funds rate, which the Fed targets in order to implement monetary policy, has remained near zero.  This so-called zero-lower-bound outcome has led many economists to question the effectiveness of additional monetary policy, and it has led some to advocate for fiscal policy—taxing and spending in order to achieve macroeconomic objectives, such as full employment; such policies are countercyclical because they are intended to smooth out economic fluctuations by working against—or counter to—the business cycle. These economists argue that fiscal policy has (wrongly) fallen out of favor, as if it were an intellectual backwater.

Moreover, because policymakers—and the legislators who must ultimately decide to tax or spend—are so reluctant to implement fiscal policy, increasingly, proponents of countercyclical fiscal policy argue for policy rules, which trigger taxing or spending based on certain features of the economy.  For example, a fiscal-policy rule might be to lower income tax rates by some specified amount when GDP growth falls below some specified threshold.  The idea here is that once policymakers—and legislators—set the policy rule, fiscal policy would be implemented if the economy underperforms (triggering the need for a policy response), whether or not policymakers were willing to implement fiscal policy at that moment.  Thus, ironically, the principled argument here for rules over discretion is turned on its head: here advocates for rules want to ensure countercyclical policies are implemented; whereas, the conventional argument for rules has been motivated by the intention to limit policy interventions—and, specifically, discretion.

The rules-based approach discussed in this session centered on semi-automatic stabilizers; in this case, changing the payroll-tax in response to state-specific cyclical downturns—the triggers.  The approach recognizes that not all regions of the country simultaneously experience cyclical downturns the same way; and, that, if not addressed with countercyclical policy, regional cyclical downturns could spill into broader (aggregate) downturns.  As for triggers, proponents of this approach recommend regional unemployment rates, which reflect regional economic conditions and tend to identify aggregate-demand shocks, which this approach seeks to counter.

Is the United States Deficit Policy Playing with Fire?

The United States federal budget balance is the difference between receipts and expenditures; economists refer to negative and positive balances as deficits and surpluses.  If deficits matter, that’s because debt matters.  The United States federal debt is the negative net accumulation of financial deficits and surpluses.  Between 1970 and 2019, the debt (held by the public in the form of outstanding Treasury bills, notes, and bonds), as a percentage of GDP, rose from 27 percent in 1970 to 78 percent in 2019.  (For more on the federal budgetary position and what it means to sustain debt, see the Morning Macro segment, “Fiscal Therapy)  This debt-to-GDP ratio attracts lots of attention.  How much debt is too much?  Economists approach this question from the perspective of sustainability: loosely speaking, the debt-to-GDP ratio is sustainable if we project it to remain constant (or shrink); it is unsustainable if we project it to grow without limit.

In 2019, the United States federal government incurred a budget deficit equal to 4.6 percent of GDP.  Budget deficits are not going away anytime soon, so let’s think about debt sustainability in the context of deficits.  Generally speaking, the debt-to-GDP ratio could be sustainable, given a deficit, so long as the interest rate the government pays on its debt (r) is less than the growth rate of GDP (g); economists affectionately refer to this condition as r < g.  Otherwise, that is if r > g, the debt-to-GDP ratio is not sustainable, given a deficit.

Prior to the Great Recession, the interest rate the government paid on its debt was often—though not always—greater than the growth rate of GDP, so r > g was typical.  And, consequently, the debt-to-GDP ratio rose (amid deficits).  Consider, for example, the period from 1970 to 2019, which I cite above, when the ratio rose from 27 percent in 1970 to 78 percent in 2019; incidentally, during most of this time, the federal government incurred budget deficits.  Currently, we exist in a relatively low interest rate environment; for the most part, as far as the federal government is concerned, r < g.  (As far as the rest of us are concerned, the r we pay is greater than the growth of household income—our g, so do not try this next bit at home.)  This low interest-rate environment has some economists, including former-AEA president, Olivier Blanchard, proposing that additional deficit-fueled spending would, on balance, improve economic welfare; the additional debt would not disadvantage future generations.

Blanchard was not able to attend this year’s annual meeting.


The 2021 AEA annual meeting will be held in Chicago, IL on January 3 – 5.

References

Hansen, Alvin H.  1939.  “Economic progress and declining population growth.”  American Economic Review, 29 (1), 1-15.

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