There was one post on Saturday, and one yesterday. Saturday’s post was “The Cases for Public Investment:”
One of the annoying aspects of the Sanders/Friedman flap was the assumption of many Sanders supporters that anyone who doesn’t accept extravagant economic projections is against a big program of public investment. Actually, it was destructive as well as annoying; aside from being an insult to progressive economists who believe in infrastructure but also believe in arithmetic, it created at least the possibility that other people would take the crash-and-burn of a particular piece of analysis as evidence that the whole case for spending more is wrong.
So let’s talk about the cases for a lot more public investment right now. Yes, cases, plural. There are at least three reasons to conclude that we should be spending much more than we are.
The first case is simply that America has an obvious infrastructure deficit, and that it has never been cheaper to address that deficit. Government borrowing costs are at record lows; markets are in effect pleading with the government to borrow and spend. So why not do it? It’s completely crazy that public construction as a percentage of GDP has declined to record lows even as interest rates have done the same:
The second case is a bit, but only a bit, harder: we are still in or near a liquidity trap, a situation in which cutting interest rates as far as possible isn’t enough to restore full employment.
The standard analysis looks something like this:
By the “natural” rate of interest I mean the short-term rate set by the Fed that would produce full employment. In the aftermath of a financial crisis, with a big private-sector debt overhang, it’s possible — and has turned out in fact — that this rate becomes negative for an extended period (and no, the possibility of slightly sub-zero interest rates doesn’t significantly change the picture.)
What this means, in turn, is an extended period during which conventional monetary policy can’t restore full employment; and while unconventional monetary policy can and should be tried,one thing that we know works is increased public spending. So there’s an overwhelming case for a burst of spending while we’re in the trap. That spending can be withdrawn later on without hurting employment, because once you’re out of the liquidity trap the Fed can offset the contractionary effects of a fiscal tightening by holding off on the monetary tightening it would otherwise have pursued.
This is why Keynes declared that “The boom, not the slump, is the right time for austerity.”
You might ask, but are we still in that condition, given that the Fed has started to raise rates? Well, it shouldn’t have — it shouldn’t be raising rates until it sees the whites of inflation’s eyes. And it would take only a modest shock to push us well into negative-natural-rate territory again. Put it this way: the asymmetric-risks story many of us have been using to argue against rate hikes is also a reason to consider increased public investment a valuable insurance policy, giving the economy headroom that might turn out to be crucial if anything goes wrong.
What about the possibility that the natural rate will stay negative for a very long time, maybe even forever? That’s the secular stagnation hypothesis, and needs a longer discussion than I have time for this morning. But suffice it say that the case for more public spending remains very strong.
Finally, there’s hysteresis: the proposition that demand-side weakness now breeds supply-side weakness later, so that there are big payoffs to boosting the economy through public spending. There’s now a lot of evidence for that proposition, with my only worry being that potential output isn’t an actual number, just an estimate that may tell us more about the dreary minds of international agencies than about real supply-side effects. More on that soon too. But it’s a further reason to spend more now, and to worry even less about any debt that we run up at today’s low, low rates.
The point is that perfectly standard, mainstream economics makes a powerful case for (much) more infrastructure spending. And this needs to be said often.
Yesterday’s post was “What Happened to the Great Divergence?”:
That’s the title of a very interesting speech by Lael Brainard of the Fed, who has been warning for a while that international finance — in particular, the importation of overseas weakness via the strong dollar — made the case for rate hikes very dubious. Now she expands on that theme:
Beginning in 2014, we saw confident predictions of a coming strong divergence in monetary policy among the major economies. To date, there has been less policy divergence in reality than had been predicted. This observation raises the question of whether there may be limits on policy divergence in current circumstances. Such limits might reflect common forces buffeting economies around the world or the powerful transmission of shocks across borders through exchange rate and other financial channels that may have the effect of front-running monetary policy adjustments in the vicinity of the zero lower bound. Put differently, predictions that U.S. monetary policy would chart a notably divergent path have been tempered by powerful crosscurrents from abroad.
As I understand Lael’s argument, it’s fairly close to what I wassaying a year ago:
Not to keep you in suspense, here’s the punchline: the US economy reaps the bulk of the gains from rising demand relative to other countries if and only if that relative rise is perceived by markets as temporary. If it’s seen as permanent – if, say, investors see strong US demand but Europe stuck in secular stagnation – we should expect a strong dollar to undo a lot of the gains.
In a world still awash in desired savings with no place to go, it’s really, really hard for any one economy to boom while the rest remain in stagnation.