Needed: New Economic Frameworks for a Disappointing New Normal
When I was taught economics lo more than a generation ago now, I was taught that there were six major and significant political-economic market and governance failures that called for action:
- failures of the distribution of income to accord with utility and desert, which called for social insurance–and we had about the right amount of that.
- failures of the market in the area of public goods, which called for government spending on physical, organizational, and social infrastructure–and we had about the right amount of that.
- failures of the demand for money to remain stable over time, which called for aggressive monetary policy to stabilize the path of total spending around its trend–and we needed to better at that.
- failures of voters to understand that low interest rate policies were ultimately counterproductive and created costly inflation, which called for independent and conservative hard-money technocratic central banks.
- voter myopia about spending and taxes, which called for pressure and institutions to make the public sphere of discussion fear deficits–and we were moving toward that.
- failures of the financial markets to actually mobilize society’s risk-bearing capacity and so make the hurdle rate for corporate investment as low as it should be, which we could do little about save trying to open up finance and teach people the benefits of diversification–and, I was taught, the equity return premium was on the decline, and would be the time I was middle-aged no longer be a first-order economic failure.
All this was in the context of the age of Social Democracy–in which we could expect fast productivity growth, a relatively egalitarian income distribution, and in which the principal socio-economic problems were those of moving toward socioeconomic inclusion for more than just well-educated white guys and keeping populist policy mistakes from disrupting the mechanism via monetary inflation or excessive government debt burdens.
This entire structure is now in ruins. Our social-democratic income distribution has been upending in an appalling manner by the Second Gilded Age. Our government, here in the U.S. at least, has been starved of proper funding for infrastructure of all kinds since the election of Ronald Reagan. Our confidence in our institutions’ ability to manage aggregate demand properly is in shreds–and for the good reason of demonstrated incompetence and large-scale failure. Our political system now has a bias toward austerity and idle potential workers rather than toward expansion and inflation. Our political system now has a bias away from desirable borrow-and-invest. And the equity return premium is back to immediate post-Great Depression levels–and we also have an enormous and costly hypertrophy of the financial sector that is, as best as we can tell, delivering no social value in exchange for its extra size.
We badly need a new framework for thinking about policy-relevant macroeconomics given that our new normal is as different from the late-1970s as that era’s normal was different from the 1920s, and as that era’s normal was different from the 1870s.
But I do not have one to offer.
Olivier Blanchard has thoughts:
…I had implicitly assumed that this new normal would be very much like the old normal, one of decent growth and positive equilibrium interest rates. The assumption was challenged…. Ken Rogoff argued that what we were in the adjustment phase of the ‘debt supercycle’…. Larry Summers argued… more was going on… a chronic excess of saving over investment [with] keeping the economy at potential may well require very low or even negative real interest rates…. I am closer to Summers… than to Rogoff. What the new normal will be matters a lot for policy design….
[Has] financial regulation… successfully reduced financial risk. There was agreement on ‘reduced,’ not so on ‘successfully.’… The discussion became granular…. Should monetary policy go back to its old ways?… Ben Bernanke’s answer was largely yes. Once economies were out of the zero lower bound, most of the programs introduced during the crisis should be put back on the shelf, ready to be used only if there was another sufficiently adverse shock…. Issue was taken on by others, in particular Ricardo Caballero…. If the central banks are in a unique position to be able to supply safe assets shouldn’t they do it? I see this discussion as having just started, raising deep issues about the private demand for safe assets, and the potential role of central bank in this context….
Judging the central bank on how it fulfills its mandate, rather than requiring it to follow a simple rule, [Bernanke] argued, is the way to proceed. I agree…. Tucker however argued for the use of macro prudential tools to deal with ‘exuberance,’ not necessarily for fine tuning in more normal times. Rubin remarked that we were not very good at telling when times were exuberant…. Lars Svensson argued that a simple cost-benefit analysis suggests that monetary policy is a very poor instrument to deal with financial risk….
The traditional objection to using fiscal policy as a macroeconomic policy tool was that recessions did not last long, and by the time discretionary fiscal measures were implemented, it was typically too late. Martin Feldstein made the point that some recessions, in particular those associated with financial crises, are long enough that discretionary policy can and should be used…. Despite questions by the chair of the session, Vitor Gaspar, on potential improvements in the design of automatic stabilizers (based on the very interesting chapter 2 of the April 2015 Fiscal Monitor), the issue did not register, and I am still struck by the lack of action on this front….
What struck me most in the discussion of capital flows was the recognition that they have complex effects…. This… has one clear implication, namely that hands-off policies are not the solution. I see this as one area where the rethinking has been striking, say compared to ten years ago…. There was no agreement on capital controls…. Ricardo Caballero touched upon the demand for safe assets by emerging market countries, and argued for a better provision of international liquidity by the IMF and by central banks….
Not all the questions I had raised in my pre-conference blog were taken up, and few were settled. Still, to go back to the title of the conference, Rethinking Macro Policy III: Progress or Confusion?, my answer is definitely: Both. Progress is undeniable. Confusion is unavoidable…