CEPR - Center for Economic and Policy Research


En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press Krugman and DeLong on Avoiding Secular Stagnation

Krugman and DeLong on Avoiding Secular Stagnation

Tuesday, 25 March 2014 08:20

Brad DeLong and Paul Krugman are having some back and forth on the problem of secular stagnation and what it would have taken to avoid a prolonged period of high unemployment. I thought I would weigh in quickly since I have a better track record on this stuff than either of them. 

The basic story going into the crash was that we had an economy that was being driven by the housing bubble. This was both directly through residential construction and indirectly through the consumption that followed from $8 trillion of bubble generated housing equity. Residential construction expanded to a record high of more than 6 percent of GDP at a time when demographics would have implied its share would be shrinking. This led to enormous overbuilding, which is why construction hit record lows following the crash. (There was a smaller bubble in non-residential real estate that also burst in the crash.) 

Consumption also predictably plummeted. This is known as the housing wealth effect. (I learned about this in grad school, didn't anyone else?) Anyhow, when people saw their homes soar in value many spent in part based on this wealth. This might have meant doing cash out refinancing, a story that obsessed Alan Greenspan during the bubble years. It might mean a home equity loan, or it might just mean not putting money into a retirement account because your house is saving for you.

In any case, when the $8 trillion in bubble generated equity disappeared so did the consumption that it was driving. You can't borrow against equity that isn't there. This cost the economy between $400 billion and $600 billion (@ 3-4 percent of GDP) in annual consumption expenditures. Between the lost construction and lost consumption, it was necessary to replace close to 8 percent of GDP. The effect of lost tax revenue in forcing cutbacks at the state and local level raised the demand loss by another percentage point or so.

Some of this gap would be filled as excess inventory of housing gradually faded and the vacancy rates came back to more normal levels. We're getting there, but still have some way to go. Some would be filled by a drop in the trade deficit, which now sits at around 3 percent of GDP, compared to a level of almost 6 percent of GDP before the crisis.

The government could fill the remaining gap with additional spending, but our cult of low-deficit politicians is insisting that they would rather keep people from getting jobs, so this ain't going to happen. Low interest rates are of course a good route to spark demand, and if we could lower real rates further with a higher inflation rate, that would be good news. But that one also doesn't seem very promising.

The other part of the demand story would be to make more progress on the trade deficit. This one is not rocket science, a lower dollar means a lower trade deficit (more econ 101). The issue of lowering the dollar is often posed as a matter of getting tough with the Chinese and force them to stop "manipulating" their currency.

We actually don't have to hide in the dark and wait to catch China in the act and then bring them to justice. China very openly maintains its currency at a level that is well below the market rate. They set a target for their exchange rate and they maintain it by buying up massive amount of foreign assets, such as U.S. government bonds. We don't have to catch them in the act, all of this is completely open and involves trillions of dollars of asset purchases.

It is also not a matter of bringing China to justice over the issue. China has found maintaining an under-valued currency to be a useful development strategy, but they also find other policies to be useful to their development strategy, like not enforcing foreign patent and copyrights or not opening their financial markets to companies like Goldman Sachs.

This suggests an obvious path for getting China to allow the dollar to fall against its currency. We simply tell them that we don't care if they enforce Pfizer and Merck's patents or Microsoft's copyrights. We also tell them they don't have to open up their financial markets to Goldman Sachs, J.P. Morgan and the other Wall Street behemoths, we just want them to raise the value of their currency.

Again, this path may not be politically viable either because of the relative power of the drug companies and banks as opposed to tens of millions of unemployed and under-employed workers, but let's at least get the cards on the table. As fans of national income accounting everywhere know, we will not be able to get to potential GDP without large budget deficits as long as we have large trade deficits (assuming no more bubbles).

There is one other item that must be on the full employment agenda especially as we approach the big March 31 deadline for Obamacare. If we reduce the supply of labor we can also get to full employment. Obamacare will be a useful step in this direction since it will give millions of workers the option not to work or to work fewer hours since they will not have to get health insurance through their jobs. This means that parents of young children will be able to spend more time with their kids, people suffering from illnesses or disabilities will be able to rest more and work less, and many older workers will be able to retire early.

There are other ways we can go to accommodate people's needs and thereby reduce the labor supply. For example more paid sick days would be good news, as would be paid family and medical leave. Many state and local governments are leading the way in these areas. Also, some paid vacation would be nice. Four weeks has been the norm in Europe for decades with some countries guaranteeing as much as six weeks of paid vacation. (Yep, it's all in the good book.)

Anyhow, there are always things that can be done. The key point is to first understand where we are. And the most important take away is that millions are suffering now not because we are too poor, but we are too rich. We don't need all the workers we have. This provides enormous opportunities for making people's lives better, if we just had the political will.


Comments (22)Add Comment
deficits, Low-rated comment [Show]
Is the patent/copyright issue enough to eliminate the gap?
written by Dave, March 25, 2014 9:29
This looks to be more accurate than what PK and BD are saying.

The issue of patents and copyrights with China is infuriating! Why we favor world-wide monopolistic rent seeking over work has to be because Obama's team is not honest about it with him. But it is doubtful that we can close the trade gap with China just by asking them to stop the manipulation. It is a first step, but there's no question to me that we'd have to do more.

Obama's patent overhaul legislation was horribly misguided as well, I believe. He sees it as a battle between Google and Microsoft, Microsoft and China, Facebook and Microsoft, Facebook and China, rather than a battle for increased innovation.
@Jeff S.
written by Dave, March 25, 2014 9:51
Dean, please correct me if I'm wrong, but if you properly balance the economy again through eliminating the trade deficit, what you fear actually cannot happen as long as we have a central bank that understands its job properly. If you don't balance the trade deficit, however, there is a possibility of a growing debt ad infinitum.

The fear that investors can suddenly demand a premium on investment, raising borrowing rates, can be 100% eliminated by the central bank by buying those bonds. It doesn't have to do it to a huge degree. If things are balanced, just the threat is enough to keep rates affordable.

The only threat to this stability comes from a role reversal. If the government is indebted to a large degree and if corporations are not, but rather they have a huge stash of cash, and if the central banks then forgets its proper role and stops driving down treasury rates and leaves it up to the market as both treasury rates and corporate bond rates increase, suddenly corporate bonds look safer than treasury bonds because of the balance sheet effect.

If you had a rogue central banker, it could allow this panic to destroy the government's ability to fund itself in favor of corporations, and you'd have a political catastrophe on your hands, or perhaps just a desired shrinking of government to your preferred size, whomever you might be.

Mathematically induced Fascism.

So be nice to your central banker and balance the trade.
Probably not going to get a lot of Southern Republican Support
written by paulpfish, March 25, 2014 10:34
Your ideas make a lot of sense, but I have never seen them supported in Texas. In fact we get the opposite from our elected representatives. The idea of a weak dollar is linked directly with higher inflation policies, so they are likely to fail for the same reason.

Here is a typical response from a Texas Republican to this idea. The quote is from U.S. Congressman Kevin Brady (R-The Woodlands) in a local article claiming low dollar policies increase the cost of gas by 54 cents per gallon. Kevin Brady is the vice chairman and top Republican on the Joint Economic Committee and a senior member of the House Ways and Means Committee:

"First, rather than point fingers at energy manufacturers, the President should be looking to his own Treasury and the Fed for answers to the high price of fuel. And second, this drives home the point that the Federal Reserve should have one mandate - price stability. Preventing inflation and preserving the value of the U.S. dollar is the Fed's role, not propping up failed mortgage giants Fannie Mae and Freddie Mac."
Or the fed could buy more
written by Floccina, March 25, 2014 10:40
Or the fed could buy more assets from outside the USA.
written by Dave, March 25, 2014 10:55
"Preventing inflation and preserving the value of the U.S. dollar is the Fed's role, not propping up failed mortgage giants Fannie Mae and Freddie Mac."

My best response to this, if appealing to the proper people, is to point out that the European Central Bank has precisely this single mandate, and the end result while perhaps desirable to Germans (depending upon what kind of person you are) isn't very desirable to many other European victims. If the US' goal is to become to the world what Germany is to the EU, then a single mandate is appropriate, but bear in mind that victims in the US and abroad will be roaming the streets without food or jobs and crowding the jails . If the mote around your castle is wide enough and deep enough, perhaps you don't care…

If you are talking to a zombie or Koch drone, then is might be more efficient to save your breath. It is hard to say.

I think politicians should talk about phasing out Fannie and Freddie by eliminating all government guarantees of mortgages. Both sides should actually agree, but the funny thing is that neither side actually wants that. They both seem to want to use the government as a profit machine.
written by liberal, March 25, 2014 11:14
Dave wrote,
I think politicians should talk about phasing out Fannie and Freddie by eliminating all government guarantees of mortgages.

If we had a land value tax, we wouldn't need these huge mortgages to begin with.
Lowering Supply
written by Tyler, March 25, 2014 11:23
How about shortening the work week to four days, but paying people like they're working five days?
written by skeptonomist, March 25, 2014 11:44
Through the 19th and part of the 20th centuries a major part of the labor movement, which was important in reducing inequality, was reduction of work hours. Also there was elimination of child labor, and maybe some reduction of women in factory work. But after the work week was set at 40 hours (the last major legislation on this was in 1937) there has been very little change, despite the entry (or re-entry?) of women into the work force. The employment/population ratio went up considerably 1960-2000, much of which was women entering the work force. Of course part of this was not voluntary, as wages stagnated and many households found that two incomes were necessary.

There is no economic or moral reason for the "full-time" work week to remain at or near 40 hours. This is not some magical value that maximizes GDP nor is it in the Bible - its current value is one set by legislation and it maximizes profit over wages as unemployment tends to remain high. The reduction to this from much longer hours involved a political, class-war battle of workers against capitalists, and the same will be true to get further reductions.
If Only?
written by Ellis, March 25, 2014 11:50
Your approach is that of looking for technical glitches in the running of an otherwise wonderful system. If only for the housing bubble... we would be living it up! Never mind that the entire economic system came very close to a complete collapse. You can't just explain that with housing, as bad as it is.

The fact is that there has been a worsening crisis since the 1970s. Recessions are getting worse, and recoveries have been getting weaker. Along with that, there has been a huge increase in the entire financial system, and along with that growing indebtedness on every level-- including government and corporate.

It's so big, you can't paper it over anymore by blaming the Republicans.
written by Alex Bollinger, March 25, 2014 1:24
Ha! I'm sure it's just a funny coincidence that everything the government could do to get the US to full employment is considered unthinkable in contemporary policy discourse.
Full Employment? Bah! Humbug!
written by Ellis, March 25, 2014 1:42
It's unthinkable, because the only real goal of government policy is to enhance and aid profits and wealth. That's why government policy is doing just fine. This is a class society. And the government serves the ruling class, the capitalists.
Catherine Rampell
written by jaaaaayceeeee, March 25, 2014 3:22

" ...millions are suffering now not because we are too poor, but we are too rich. We don't need all the workers we have. This provides enormous opportunities for making people's lives better, if we just had the political will".

Along with your wrong-deficit hawks and wrong-spending cutters, policy makers uninterested in reducing the labor supply beneficially are still blaming the unemployed, or seeing self-perpetuating unemployment, like Catherine Rampell:
The Blur of Clarity
written by Larry Signor, March 25, 2014 3:34
Dean, I agree with the points you have made, but there is a theme you cannot deny PK. Inflation is the great leveler. Holding fed rates at .5% and allowing an inflation rate of 3-4% for 2-3 years would change the economic landscape tremendously and facilitate the actions which you propose (I agree there is a low probability of this, a sad incompetence on the part of policy makers). Think of it as a controlled mini-bubble. Stacked on top of our "normal" GDP growth, this would bring us much closer to full employment, reducing trade deficits and the value of extreme wealth (via dollar devaluation), than current policies. If that, is in fact, our goal, which current policy does not indicate. I know this is repetitive, but maybe some policy makers can read. (Of course I am ignoring progressive tax policies, monopsony,
patent privilege, and the financially driven political perversions of our current system.) I value your specificity over a more macro-philosophic approach. Facts IS facts.
just stop selling debt! US can end currency manipulation yesterday
written by indiana patriot, March 25, 2014 7:46
One quibble:

The US sells China the debt that allows it to "manipulate" its currency.

The US doesn't need to consult with China or any other country; if we are unhappy with a too strong dollar, just stop selling US securities to foreign governments.

Many governments do this; the Koreans and Chinese most prominently don't allow any foreign entities to purchase govt. debt. The US could easily do the same.

Alternatively, the federal reserve could announce that it's willing to purchase foreign currencies in unlimited quantities at slightly below current exchange rates. The yuan, won, Danish kroner, Japanese yen and Singapore dollars will come rolling in to chase arbitrage profits.

Pushing down the value of the dollar is totally within our own capabilities independent of anyone else;

Or in other words; stop blaming foreigners, the real negotiation is with ourselves (or really the Wall Street / Treasury / Fed axis [of evil?])
written by Uncommon sense, March 25, 2014 8:09
"There is one other item that must be on the full employment agenda especially as we approach the big March 31 deadline for Obamacare. If we reduce the supply of labor we can also get to full employment."

The easiest way to reduce the supply of labor would be to cut down on immigration. Why is the United States adding over a million (legal) immigrants a year in a depressed labor market? The Gang of 8 bill would increase the number of job seekers by tens of millions.
written by Gman, March 25, 2014 8:45
The only immigrants this nation needs are rich ones who spend but do not work. Instead we get a bipartisan corperate hr depts dream.

FED and ECB cannot be compared
written by ekemen, March 26, 2014 3:49
EU doesn't have a fiscal union, so it wouldn't make sense to compare FED and ECB policies. This is also the main reason that Germany enjoys the monetary union and free trade the most...
written by JSeydl, March 26, 2014 6:22
No qualms here. But in light of Piketty's new book, one additional point should be made. Dean has the idea that the US should be running trade surpluses to countries like China, because that's what neoclassical econ says should be happening. It's a great theory, but that's not how successful development has been had in the past. The countries that liberalized very early and imported massive amounts of capital from the West have had very poor development tracks -- their industries end up being owned by Western capitalists, who suck the land dry through rents. The ones that used protectionism and state policies to promote the export sector have, one the other hand, developed relatively quickly. China did what was in its best interest. And going forward, it will continue to do what's in its best interest. Neoclassical trade theory offers no serious path to prosperity for emerging markets - many of which i think are starting to notice this.
Raise the minimum and cut the maximum
written by Jim Hannley, March 26, 2014 5:10
Your points are well taken, Dean. Your point about China is especially good. Since we can't make them bring a true value to their currency, let's take action on what we can control. As far as stimulating the demand side, let's not omit raising the minimum wage (as you have advocated elsewhere) and what about a reduction in the maximum interest rate on credit cards? I imagine that cutting that from 29.9% even to 24.9% would significantly impact disposable income for millions of indebted Americans.
We are Too Rich
written by Eugene Patrick Devany, March 27, 2014 9:14
"We [in the top 10%] are too rich" acquiring all gains in net wealth for decades and a 75% share. That leaves only 24% of net wealth for the middle class and 1% of U.S. net wealth for the poorer half of the population.
With fewer workers getting a smaller share of G.D.P. the payroll taxes have become a burden on both job creation and real take-home pay. Bill Gates said two weeks ago that they should be eliminated to create jobs and a VAT would be a good replacement. Piketty thinks we need a net wealth tax at the top but a 2% net wealth tax (excluding $15,000 cash and $500,000 retirement) could be combined with an 8% income tax for those at the bottom. The wealthy could pay a flat 26% on income (plus capital taxes on gains, estates and gifts) if they are "Too Rich".
Secular stagnation caused by wealth inequality
written by Pookah harvey, March 27, 2014 10:52
Two interesting articles showed up recently. One in the new blog House of Debt, Economic Commentary from Atif Mian and Amir Sufi ( http://houseofdebt.org/2014/03...omics.html )

"But perhaps even more interesting are the implications (of wealth inequality)for the secular stagnation hypothesis, which holds that we are in a long-run stagnating economy because of inadequate demand. Is it a coincidence that the secular stagnation hypothesis is being revived exactly when income inequality is accelerating? If a higher share of income goes to the wealthiest households who spend very little of it, then perhaps these two trends are closely related."

Another blogger quotes former Fed Chairman (1932-48) Marriner Eccles, from his memoir, Beckoning Frontiers (1966):

"As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth – not of existing wealth, but of wealth as it is currently produced – to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations.

But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped."

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.


Support this blog, donate
Combined Federal Campaign #79613

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.