April 09, 2017
Justin Wolfers had a piece in the NYT today warning that we face a situation in which the Fed may often find itself facing the zero lower bound, where it is unable to stimulate the economy further by lowering the short-term federal funds rate that is directly under its control. Wolfers notes that this can mean that growth ends up being slower and unemployment higher than would otherwise be the case. He argues that it should be possible to counteract this weakness with more aggressive use of countercyclical fiscal policy, which means increasing government spending during downturns.
While Wolfers’ argument for the merits of countercyclical fiscal policy is reasonable, it is worth stepping back and asking about the origins of secular stagnation. The basic story is that we are looking at an economy in which investment spending is weak, partly due to low labor force growth, and consumption spending is also weak, in part due to the upward redistribution of income. (Rich people spend a smaller share of the their income than the middle class and poor.)
However, an important part of the demand story is net exports. Back in the old days, economists used to argue that rich countries should run trade surpluses. The idea is that capital is relatively abundant in rich countries, while it is relatively scarce in developing countries. This meant that capital would get a higher return in developing countries than in rich countries, so that we should expect rich nations to be net lenders of capital to developing countries. This lending would facilitate their growth.
The implication of being net lenders is that rich countries would run trade surpluses with developing countries. This would allow them to feed and house their populations, even as they built up their infrastructure and capital stock.
As it turns out, the world economy has not followed this course. While the rich countries as a whole (not the United States) were big net lenders in the 1990s, after the East Asian financial crisis in 1997, the flows switched course. Developing countries became big net lenders, as they began to run large trade surpluses especially with the United States. (The harsh terms of the I.M.F. bailout, engineered by Larry Summers, Robert Rubin, and Alan Greenspan, deserves the blame here.)
This matters for the secular stagnation story since the United States is still running a trade deficit of around 3.0 percent of GDP (close to $540 billion a year). If we envision a world in which consumption, investment, and government spending were unchanged, but trade was balanced, we would have far more demand in the economy.
The elimination of the trade deficit would have an effect on demand that is equivalent to a jump in annual investment, consumption, or government spending of $540 billion. This would almost certainly be large enough to push the economy to full employment or beyond. In other words, we would not be discussing secular stagnation if trade was balanced.
Of course, there is no magic to balanced trade, but the point here is straightforward, a big part of the secular stagnation story is the trade deficit. It creates a gap in demand that is not easily filled. It might be worth some thinking as to why trade and capital flows are not following the textbook model and trying to take steps to address this problem (e.g. lower the value of the dollar).
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