Wednesday, December 30, 2015

Response to Krugman: More on Secular Stagnation

Paul Krugman was "quite unhappy" with a paragraph in my blog post last Monday concerning "Secular Stagnation: An Update."  In his characteristic high-decibel mode, Paul manages in a single post to use the phrases "both wrong and, to some extent, cowardly," "change the subject," "actually engaged in an act of evasion," "refusing to take sides is a dereliction of responsibility," and more. I confess that I am generally dubious as to whether dueling blog posts shed more light than heat.  But once Krugman gets done tossing sand around the sandbox, what is actually at issue here?

To review the bidding: My original post was focused on a recent essay by Larry Summers on "secular stagnation," the concern that the economy may be entering a period of sluggish investment and slow long-run growth--at least if appropriate policy steps aren't taken. In the paragraph that bugged Paul, I expressed doubts that fiscal and monetary policy would address a long-run secular stagnation problem, and instead suggested focusing on a structural pro-growth agenda. Paul views this as wrong, cowardly, subject-changing, evasion, dereliction, etc. because as he writes: "But if you have a persistent problem of inadequate demand — which is the secular stagnation argument — then find things that will boost demand. Don’t throw up your hands and whine that you can’t, and/or use demand-side problems to argue for other stuff that has no obvious relevance to the problem."

It's an strong claim that the long-run secular stagnation problem is exclusively a demand problem To put it another way, Krugman's view is apparently that US long-run productivity growth would be just fine if we would only make more aggressive use of macroeconomic tools to boost aggregate demand, and anyone who raises any non-demand approach is wrong, cowardly, subject-changing, evasion, dereliction, etc.

But the claim that secular stagnation is exclusively about macro-demand is not obviously true. The originator of the "secular stagnation" argument back in 1938, the prominent US economist Alvin Hansen,  gave three reasons for his concern that a lack of the investment could lead to ongoing  stagnation: a lack of invention, a lack of discoveries of new resources, and slow population growth. In other words, the originator of "secular stagnation" believed that incentives for invention were affected by invention and developing resources, not just by the quantity of demand. A number of modern writers on secular stagnation discuss non-demand angles, too.

What about the fighting secular stagnation by using fiscal and monetary stimulus to push for more demand? On the topic of fiscal stimulus, Krugman writes: "First of all, we did not, repeat not, have massive stimulus." As evidence,  he offers a chart on the budgetary effect of one piece of legislation: the American Recovery and Reinvestment Act of 2009. Paul concludes that because this one law had an effect of 2% of GDP, total fiscal stimulus was 2% of GDP. But as I assume Paul knows perfectly well, one law doesn't summarize fiscal policy.  Here's a graph showing budget deficits since the 1930s as a share of GDP. The deficits for the four years from 2009 to 2012 (9.8%, 8.7%, 8.5%, and 6.8% of GDP, respectively) are the four largest annual deficits since 1930, barring only the deficits of the World War II years. (And yes, if you would prefer to look at cyclically adjusted deficits, CBO estimates still say that 2009-2012 were the four largest annual deficits since World War II.)

As I've written on this blog a number of times, I think those very large budget deficits from 2009-2012 were overall a worthwhile and useful policy (although like most people I would have had some personal preferences in how to tweak the details).  Overall, the ratio of US debt held by the public to GDP rose from about 36% in early 2008 to a debt/GDP ratio of 72% by early 2013-- a rise of 36 percentage points. As I've written before in this blog,
"For comparison, the sizable Reagan budget deficits of the 1980s increased the debt/GDP ratio from 25.8% in 1981 to 41% by 1988—a rise of about 15 percentage points over seven years. During the George W. Bush years, the debt-GDP ratio went from 32.5% in 2001 to 40.5% in 2008—a rise of 8 percentage points in eight years. Going back to the Great Depression, the debt/GDP ratio rose from 18% of GDP in 1930 to about 44% in 1940 – a rise of 26 percentage points over 10 years. The only comparable U.S. episodes of running up this kind of debt happened during major wars. For example, the federal debt/GDP ratio went from 42.3% in 1941 to 106.2% in 1945—a rise of 54 percentage points in four years. From this perspective, the fiscal stimulus from 2008 to 2012, as measured by the rise in the debt/GDP ratio, has been about about two-thirds of the size of World War II spending."
On the topic of monetary policy, my essay expressed doubts that it would address secular stagnation. For the record, I write as someone who supported the Fed's monetary policy actions of reducing interest rates and engaging in quantitative easing during the Great Recession and in the years just after, but also someone who has expressed fears that those policies may have been extended too long.

What Krugman apparently views as a critique of this position sounds like this: "Monetary policy has indeed had difficulty gaining traction. But that’s exactly what anyone who thought through the implications of the liquidity trap — which, you know, some us did long before the 2008 crisis — expected to happen. And what such analysis suggests is that the right solution to this problem, if you can get it, is higher inflation expectations."  So it's apparently wrong, cowardly, subject-changing, evasion, dereliction, etc. for anyone other than Krugman to express doubts on using monetary policy to boost demand, but if Paul says monetary policy under current economic conditions hasn't worked well, wasn't expected to work well, and maybe can't work well ("if you can get it"?!), then apparently it's all hunky-dory. Clearly, some advice-giver who has no problem telling other people what they have a responsibility to say needs to tell Paul: "Don’t throw up your hands and whine that you can’t."

So, quick summary for an overlong post: I believe that using fiscal and monetary policy to boost aggregate demand during the recession and in the years immediately after made sense. On fiscal policy, Krugman's view on fiscal stimulus from 2009-2012 is apparently "too small, but worked great," while my own view is "about the right size, and worked OK." While I do not obsess over cutting budget deficits in the short-run, I am skeptical that much larger and sustained deficits are the answer to the long-run secular stagnation issue. On monetary policy, I apparently agree with Krugman that monetary policy in general has a hard time during a liquidity trap, and that it may have trouble addressing secular stagnation, too.

When it comes to the long-run problem of secular stagnation--which was after all the topic of the original post--I agree with the view originally expressed by Alvin Hansen as well as by others since then that the pace of invention and ability to develop new resources of all kinds can be important drivers for investment. I disagree with Krugman's view that secular stagnation is purely a demand problem. I also disagree that when it comes to addressing the problem of sluggish investment and the risk of secular stagnation, raising non-demand approaches is cowardly, subject-changing, evasion, dereliction, etc. Isn't it possible any more that two people just honestly disagree?

Follow-up note: Here's a follow-up comment from Krugman, which I had not seen before writing the post above. My original post was called "Secular Stagnation: An Update," and thus, I asked whether monetary and fiscal policy could address long-run secular stagnation. Krugman's latest post doesn't mention secular stagnation, or whether monetary or fiscal policy can address it, and instead focuses on how fiscal policy was needed as countercyclical policy in the previous recession and will be needed in the next one.

Also, for the record, just because Krugman puts quotation marks around a statement one sentence after my name, it would be unwise to assume that he is actually quoting me or even paraphrasing me with any accuracy, rather than just naming a position he wishes to argue against.

As noted above, I agree with the importance of countercyclical fiscal policy during recessions, but because it's important in recessions doesn't mean it's a equally useful tool in an economy with a 5% unemployment rate facing a risk of long-run sluggish investment and secular stagnation. In this post, Paul's latest method of measuring fiscal stimulus--to show that fiscal policy was far too small from 2009-2012--has now become the change in government employment. Readers can make their own judgment about whether an upsurge in government employment is a plausible long-run approach to improving investment incentives. Readers can also judge for themselves whether encouraging government employment is a more appropriate measure of fiscal policy than, well, the actual size of fiscal deficits as discussed above. Naturally, in this more recent post Krugman has more about how the cowardly, subject-changing, evasion, dereliction, etc., people like me now "just make up a policy history that never happened." Readers can make their own judgments on this theme, too.