Must-Read: Greg Ip: Needed: A Contingency Plan for Secular Stagnation

Must-Read: Um. No. Larry Summers is right. The sharp and usually-reliable Greg Ip is wrong. This opinions-of-shape-of-earth-differ-both-sides-have-a-point framing is simply wrong.

The right level of the debt-to-GDP ratio is primarily a function of r-(n+g), the difference between the real interest rate r on Treasury debt and the real growth rate g of productivity plus the real growth rate n of the labor force. A reduction in r accompanied by an equal or smaller reduction in (n+g) is not a first-order reason to reduce government spending or the deficit now–or to postpone or cancel plans to increase the deficit right now that would otherwise be good policy

Greg Ip: Needed: A Contingency Plan for Secular Stagnation: “If Larry Summers is right…

…the most direct response is more expansionary fiscal policy…. But policy makers are rightfully wary about acting in the face of so many contradictory signals. In the U.S., unemployment is moving lower and stocks are hitting new highs. Bonds could be pricing in secular stagnation, or merely a greater bias toward hyper-stimulative monetary policy by central banks…

Why are policy makers rightfully wary? All Ip says is:

Paolo Mauro of the Peterson Institute for International Economics notes that countries have often overestimated their long-term potential growth, resulting in too-high deficits and debts…

And chasing the link:

Paulo Mauro: Fiscal Policy in the Era of Stagnation: “Policymakers often mistake a long-lasting growth slowdown for a temporary slowdown…

…and systematically fail to increase the primary fiscal surplus sufficiently when the long-run economic growth rate declines. Economic history provides several examples of debt crises or near-crises caused by unexpected, long-lasting slowdowns in economic growth that were not recognized in time…. Ignoring a permanent slowdown in the rate of economic growth can lead to policy mistakes. For example, a country projecting a stable government debt ratio of 100 percent of GDP over the next decade or two would experience an increase in that ratio to 140 percent in 10 years if growth turns out to be 1 percentage point lower than assumed. As deficits rise, the ratio would balloon to more than 200 percent after 20 years…

Source: P. Mauro, R. Romeu, A. Binder, and A. Zaman, 2013, A Modern History of Fiscal Prudence and Profligacy (link is external), IMF Working Paper 13/5, Washington: International Monetary Fund.

The implication Ip takes from this is simply wrong. Slower future growth is a reason to slow the future growth of real government spending. It is a reason to cut the level of spending now–or to avoid increases in the level of spending that would otherwise be good policy–only if the slower expected growth is unaccompanied by an equal reduction in Treasury interest rates. But that is not the case: our reduction in expected future economic growth is accompanied by a larger reduction in Treasury interest rates.

July 18, 2016


Brad DeLong
Connect with us!

Explore the Equitable Growth network of experts around the country and get answers to today's most pressing questions!

Get in Touch