Keynesian Macroeconomics for the 21 st Century Part 3: Demand Dynamics, Inequality and Secular Stagnation YSI INET Lectures Edinburgh, Scotland October, 2017 Steven Fazzari Washington University in St. Louis Departments of Economics and Sociology Weidenbaum Center on the Economy, Government, and Public Policy
Understanding Recent Experience AOermath of the Great Recession: slow recovery Brief empirical case for secular stagnauon Inadequacy of supply-side stories Strong case for sluggish demand growth Household demand dynamics Role of inequality Government Reverse Say s Law: demand leads supply A few thoughts on policy
Recent Stagnation (Peak-to-peak growth of real GDP per capita) Peak Dates Total Growth (per capita) Growth per Year (per capita) 1973:4 to 1979:3 11.9% 1979:3 to 1990:2 25.0% 1990:2 to 2000:2 24.2% 2000:4 to 2007:4 10.9% 2007:4 to 2017:2* 5.6% 1.8% 2.1% 2.2% 1.4% 0.6% *Final cycle is incomplete
An Excessively Optimistic Forecast (Evolution of CBO Real Potential Output for 2017:Q2) 20.00 19.50 Trillions of 2009 Dollars 19.00 18.50 18.00 17.50 17.00 Drop of 12.6%--$2.8 trillion (2009 dollars) 16.50 16.00 January 2007 January 2009 January 2011 January 2013 January 2015 October 2017 Time of Forecast
Growth of Labor Force Participation (Percentage points, smoothed year over year) 0.8 0.6 0.4 Incomplete recovery before 2007 0.2 0.0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016-0.2-0.4-0.6-0.8 NegaUve unul 2016; Hardly any recovery -1.0 All Ages 25-54
Stagnation through the Mainstream Lens Persistent: 10 years since peak; 8 years since trough We are beyond the short run ConvenUonal view: Keynesian effects should have been corrected Some qualificauon for zero lower bound on short rates But Fed is raising rates now Therefore, it must be the supply side Bad policy: it s all Obama s fault Bad luck: structural supply-side shocks and mediocre new normal Let s look
Labor Market Mismatch? (The Beveridge Curve) 4.5 4.0 3.5 Vacancy Rate 3.0 2.5 2.0 1.5 1.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 Unemployment Rate
Lousy Business Capital Investment? (Nominal nonresidential Fixed Investment / Nominal GDP) 17.0% 16.0% 15.0% Bubble 14.0% 13.0% 12.0% 11.0% 10.0% Rather normal recovery 9.0% 8.0% Era of investment-led growth 7.0% 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015
Weak Innovative Activity? (Private R&D to GDP) 1.8% 1.7% 1.6% 1.5% 1.4% 1.3% 1.2% 1.1% 1.0% 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016
Supply or Demand? (Real) Interest Rates will Tell 10.00 8.00 6.00 4.00 2.00 0.00 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016-2.00 10-Year T Bond - Core PCE Infl 5-Year T Bond - Core PCE Infl 10-Year TIPS Real Yield
The Demand-Side Theoretical Lens No automauc or policy mechanism to restore AD to Y* beyond the short run Demand growth dynamics are proximate determinate of economic acuvity To understand stagnauon, look at the demand generauon process
Household Demand: OMG! (Adjusted household demand based on Cynamon & Fazzari, 2017) 11500 11000 10500 10000 9500 9000 8500 8000 7500 7000 6500 6000 5500 5000 4500 4000 Trend re-joined in past cycles 2016 Gap: 21.7% $2.3 trillion 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Real Adjusted Household Demand 2000-2006 Trend (HH Dem)
Weak Household Spending and the Stagnant Recovery (Based on Cynamon-Fazzari Review of Income & Wealth, 2017) 130.0 125.0 120.0 115.0 Real Household Demand Profiles (PopulaRon Adjusted) Index Peak=100 110.0 105.0 100.0 95.0 90.0 85.0 1978-1989 1989-2000 2000-2006 2006-2015 80.0 1 2 3 4 5 6 7 8 9 10 11 12 Years Since Peak
Historic Shift of Demand Generation Past trend not structural, but what economy needed Pre-crisis demand growth required unsustainable household finance But now the consumer age financial dynamics have changed Severe and persistent demand stagnauon Consistent with interest rate data and generalized correlauon of weakness across sectors
Government Did Not Replace Households 6000.00 5500.00 5000.00 4500.00 4000.00 3500.00 3000.00 2500.00 2000.00 1500.00 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Total Government ConsumpUon, Investment, & Medical 2000-2006 Trend
It Could Have Been Worse Net Exports / GDP 2.0% 1.0% 0.0% 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014-1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0%
Nuanced Role for Inequality Rising inequality as explanauon for stagnant demand Rich spend or recycle a smaller share of income than others Timing problem Borrow-and-spend era postpones demand drag Aided and abeqed by the financial system! Not inequality vs. financial expansion Inequality and financial expansion Again, dynamics of demand generauon Great Recession forces middle-class demand down More in line with stagnant incomes But we needed that demand
Inequality in a Keynesian Growth Model Autonomous demand and the supermuluplier: Income distribuuon between H and L groups (λ), spending propensiues (α), and tax rates (τ) Two problems (1) Loss of autonomous consumpuon and government spending (2) Lower supermuluplier due to rising inequality #1 abrupt; #2 slow Simple calibrauon (Cynamon & Fazzari, EJEEP, 2015) MulUplier alone can explain at least 10 percent
Demand Leads Supply Current US situauon No huge output gap despite stagnauon Mainstream: unfortunate new normal AlternaUve: weak demand lowers supply Channels Investment and technological disseminauon Pressure for labor-saving innovauon (Duq: necessity is the mother of invenuon ) Endogenous labor supply: parucipauon and immigrauon Reverse Say s Law
New Results (Fazzari-Ferri-Variato) Demand-led growth supermuluplier model Review of Keynesian Economics, 2013 Harrod model with instability contained New paper adds endogenous adjustment of supply Technology and labor supply channels Key results: Growth driven by demand Steady state growth led by autonomous demand Supply accommodates different demand paths Slow demand growth drags supply down with it AcceleraUon of demand pulls supply up Limits to how far supply can be pushed
Consequences A disappoinung recovery Deleveraging not enough to restore robust demand growth Does not fix root cause of rising income inequality Inconsistent call for smaller government without addressing demand gap Where is the engine of demand growth? Recovery relies in large part on spending of the affluent
The Af`luent as Growth Engine? 260 Index of Real Consumption, Bottom 95% and Top 5% (1989=100) 240 220 200 180 160 140 120 100 80 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Bottom 95% Top 5%
What to Do? AqenUon to demand growth necessary SkepUcal about monetary policy and QE Full employment (Baker & Bernstein, Atkinson, many others) Helps address inequality Public infrastructure Middle-class tax cuts, possibly money financed Employer of last resort Quality jobs with adequate pay Possibly contract with private sector InsUtuUonal changes to favor wage growth across the income distribuuon