Thursday, March 6, 2008

Roach & stagnation

In his recent New York Times op-ed piece, Steven Roach says:

The Bank of Japan ran an excessively accommodative monetary policy for most of the 1980s. In the United States, the Federal Reserve did the same thing beginning in the late 1990s. In both cases, loose money fueled liquidity booms that led to major bubbles.

But why is it excessively "accommodative monetary policy"?

Without this kind of monetary policy in the late 1990s, the US economy would likely have stalled in 1996 or 1997 or thereabouts. The short period of close-to-full employment at the end of the decade would not have happened. Without this kind of monetary policy, the recession in 2001 would likely have been deeper and longer, with even more negative impact on workers. It seems like the US economy cannot have half-decent growth of demand without "excessively accommodative monetary policy"!

What's the problem? To my mind, it's the way that the distribution of income and wealth have steadilyly tilted to the right (since 1980 or so), with the rich getting richer (and richer and richer...) and the rest of us facing stagnant or even falling incomes. This has led to a stagnation of mass consumption (absent expansion of credit) or what I've termed the "underconsumption undertow."

Just as a strong swimmer can beat an undertow, an economy can enjoy demand growth, roughly in step with its potential growth, despite an underconsumption undertow. (For the mathematical condition that must be met for this to happen, see my 1994 RESEARCH IN POLITICAL ECONOMY article.) This can happen due to private nonresidential fixed investment, as happened in the late 1990s. It can happen due to investment in housing and credit-based expansion of consumer spending, as has happened in the post-2001 period until recently. It can also happen due to increased luxury spending, as has happened since about 1980 or so, accelerating in recent years. With stagnant underlying consumer spending (sans credit expansion) in place, all of these props but perhaps the last (i.e., increasingly luxury spending) require what Roach calls "excessively accommodative monetary policy."

The problem is that relying on any of these props makes the economy increasingly unstable, i.e., prone to collapse. Fixed nonresidential investment is notoriously less stable than consumer spending. So is luxury spending -- since, after all, it's not really needed. Housing investment is also unstable, fluctuating more than most. And credit-based consumption spending leads to the accumulation of debt, which is hard to sustain. In a time when the Federal government's purchases (G) were shrinking as a percentage of GDP, these private-sector sources of instability become increasingly important.

(Federal G shrank relative to GDP from 1991 to the present, with an up-tick about 2001 to 2004 which did not cancel out the over-all trend. The up-tick partly reflects the increase in military spending. State & Local purchases are ignored because those governments behave more like consumers, varying purchases with tax revenues.)

So the general growth story that the US has followed as a way to deal with the underconsumption undertow has been to use "excessive monetary accommodation" to pump up bubbles, not just financial but real ones (based in spending on goods and services). This has lead to what the late Hyman Minsky called "financial fragility" -- plus real fragility. The fragility has led to recessions.

As Roach notes, the 2001 recession and the current one (if it ends up being classified using that term) both involved bubbles popping: underlying instability came to the top. He then suggests that infrastructural investment (and if the US is lucky, export growth) can fill the gap. Hopefully, it will be "green" investment. My friend Julio adds the Clintonesque point that the government could invest in "human capital" (i.e. education). That's fine, but I would add in basic research, public health, reconstruction after disasters (think New Orleans), and the like. Then, the government should not try to fund these investments out of a balanced budget but instead by using credit. After all, corporations don't run balanced capital budgets.

The increased role of government sure fits with the normal tendency of capitalism that results from what Engels calls the contradiction between socialized production and private appropriation (of profits). That is, all else constant, this contradiction drives the capitalist state to play a bigger and bigger role (at least until things have settled down, the way they did in (say) the 1950s). It socializes private losses.

But what about raising (after tax) wages, to strike a direct blow at the underconsumption undertow? In theory, this could make bubbles unnecessary to stable growth. This kind of solution seems totally forgotten. That's likely because it involves reversing the ongoing one-sided class war.
--
Jim Devine

5 comments:

Econoclast said...

I'm leaving a comment so that future comments will be e-mailed to me.

Joe K said...

I think you are exactly right in your assessment of the problem. As you probably know (from the Fed Flow of Funds), during this decade (through 2006) Govt debt growth as a % of GDP was fairly stable, but the growth of Household debt in current $ (volume of $ not %) was double the growth of GDP.

If we assume that debt growth at the level of GDP growth is sustainable and that the "excess" growth entirely affected GDP, then without this excess, GDP growth (mal-distributed as it was) would have been zero.

So much for "robust" tax-cutting supply-side
growth.

Joe K.

Kaleberg said...

I like the term "underconsumption undertow". Conventional wisdom has it that rich people are stupid, and they will invest money in creating products that no one has money to buy. In the 1960s, before the right won the class war, publications like Business Week had sections on regional income around the country. Rising income meant investment opportunity. That was a good thing.

Nowadays most companies don't have a clue, so they see rising income as a negative. It costs more to pay for labor. This leads to a downward spiral of lower pay and weaker investment climate. You can plaster it over with low interest rates, but the real trick is to get money in people's pockets, and then get it back out again.

reason said...

I had a comment lost. Hope this is not eventually duplicated.

So what do want to happen? Increasing debt/income ratios for the poorer members of your society? I remember being impressed by an argument I have never heard before (because probably we have never had consumer growth fueled by borrowing rather than income growth before), that debt financed growth pushes up profits share of income. Debt financed spending is an income for business but not an expense.

Just so you don't think I'm just negative, I suggest three things should be done:
1. Direct redistribution (transfers and spending that directly helps the poorer parts of the community)
2. Active competition policy to drive down profits and prices
3. Tackling the problems of the (currently disfunctional) international finance system so that currency prices more accurately reflect trade reality.

Yep, I think macro is overrated and micro neglected.

Econoclast said...

JoeK writes: > I think you are exactly right in your assessment of the problem…<

Thanks!

Kaleberg writes: >I like the term "underconsumption undertow". <

Thanks!

>Conventional wisdom has it that rich people are stupid, and they will invest money in creating products that no one has money to buy. In the 1960s, before the right won the class war, … Rising income meant investment opportunity. That was a good thing.

>Nowadays most companies don't have a clue, so they see rising income as a negative. It costs more to pay for labor. This leads to a downward spiral of lower pay and weaker investment climate. You can plaster it over with low interest rates, but the real trick is to get money in people's pockets, and then get it back out again.<

I don’t think rich people are particularly “stupid.” Rather, they face greater leeway than the middle, working, and poor classes, a greater ability to be stupid without it leading to disaster. Paris Hilton can mess up her life, but she’s still rich. If most people acted the way she does, we’d be in the poorhouse (as it were).

The problem is that the political economy has changed. In the 1950s and 1960s, the U.S. economy was largely self-centered, with high wages providing demand for domestic products. This was because the U.S. was on top of the economic, financial, military, and political world (within the capitalist sphere), only beginning to face competition from Germany and Japan. (South Korea and China weren’t on the economic map.) Businesses had not gotten very far down the road toward capital flight, while there were more restrictions on international trade.

Soon thereafter, the bosses began to emulate what Marx & Engels wrote back in 1848: the capitalists have no country. All they care about is profits. But this was not a conscious decision as much as a sea change due to a large number of small decisions, along with the rise of international competition, the loss of the war against Vietnam, etc.

Reason wrote: >So what do want to happen? Increasing debt/income ratios for the poorer members of your society?<

I thought that I said that we could raise wages. All else constant, this would reduce debt/income ratios by raising the denominator.

> I remember being impressed by an argument I have never heard before…, that debt financed growth pushes up profits share of income. Debt financed spending is an income for business but not an expense.<

Yes, as left-Keynesians point out, all else equal, debt-financed spending raises the ability of businesses to realize profits and total profits reaped in society as a whole. It doesn’t matter if it’s debt-financed consumer spending or debt-financed spending by the businesses themselves.

But that does not raise the amount of profit per unit of output. Instead, that depends on the gap between labor productivity and real wages. The higher the gap, the higher profitability per unit of output.

Of course, it’s not total profits or profits per unit that count in the end, but profits reaped per unit of capital invested, but that’s another issue.

>Just so you don't think I'm just negative, I suggest three things should be done...<

This is too big a issue for me to get involved with today.

But, don’t you think “reason” is a bit too pretentious as a nom de web?

Jim D.