In Debate Over ”Secular Stagnation,” Don’t Let Legitimate Concerns Over Inequality Let Austerity Off the Hook

The debate over “secular stagnation” started by Larry Summers and Paul Krugman continues on. Contributions from Jared Bernstein, Dean Baker, and Daniel Davies are worth reading (as are plenty I’m missing, for sure).

The root question being discussed is whether or not the shortfall in aggregate demand that drove the Great Recession and continues to depress the U.S. economy (and other advanced economies) is something that will afflict us for a long time, and if so what to do about it.

Historically, the prospect of demand shortfalls lasting a decade is not something that worried macroeconomists. The general assumption was that economies were pretty resilient, and so long as the Federal Reserve cut short-term interest rates as downturns loomed, recessions would be short and recoveries rapid. And for recessions in the U.S. before 1990, that seemed borne out by the data. Yet the last three recoveries have been slow—and each one slower than the last. And the recovery following the 2001 recession really only happened when an enormous asset bubble in housing pumped hundreds of billions of dollars of demand into the economy, and even with this enormous (and ephemeral) boost, the recovery was still anemic. Hence the concerns over “secular stagnation,” or, demand shortfalls that linger on for a long time.

Yesterday’s addition to all of this, from the BBC, discusses an implicit debate between Krugman and Joseph Stiglitz about whether or not the inequality is a key influence depressing demand and making recovery so hard.

It is awfully easy to believe that the huge redistribution of income upwards over the past generation of U.S. economic life should indeed, all else equal, put downward pressure on aggregate demand. This is simply because richer households save more (PDF), so transferring more money to them reduces consumer spending. The objection to this is that when the economy is performing well, extra savings accruing because of this income redistribution are channeled smoothly into demand-creating investment in plants and equipment and hence no demand shortfall occurs due to redistribution. And even if it takes an interest rate cut engineered by the Fed to accomplish this seamless channeling of savings into investment, no problem. The rebuttal to this objection is that the “zero lower bound” on interest rates does raise a problem with channeling savings into investment, and this problem has not just been theoretical in recent years.

So, is this what happened in the U.S. economy—has shifting money away from low and moderate-income families steadily strangled demand? Well, no. In fact, the personal savings rate plummeted over most of the period of the Great Redistribution (and since savings is the inverse of consumption, this simply means that the redistribution did not lead to a slowdown in consumer spending).

Rich people do save more than everybody else in the cross-section, so transferring money from rich to poor today (say by pairing a tax increase on rich households with transfer payments to poorer households) would unambiguously boost demand and help recovery. But over the last couple of decades transferring money to the rich did not starve the economy of consumer spending, as the rich went on a consumption spree. This is pretty easy to infer—rich households claim very disproportionate shares of overall income. The top 5 percent, for example, account for about 38 percent of overall income in the Piketty and Saez data and their savings rates are well more than double households in the lower 95th percentiles. In short, any huge change in the overall personals savings rate must, in the end, be heavily influenced by them.

So, the simplest story that the huge income transfer from the bottom and the middle to the top mechanically strangled consumption growth in recent decades doesn’t fit the facts. To make inequality a piece of the puzzle (and I think it is one), one needs to wrestle not just with the rise in inequality, but the role of asset bubbles and the rise of what Daniel Davies has called “The Great Trans-Pacific Imbalance, the global savings glut, the ‘China Effect,’ what have you.”

But staying on inequality just for a last paragraph or two, let’s just note what it means about sources of demand-growth in the U.S. economy. It is often decried that our economy depends so heavily on consumption spending. In one sense, this is often overblown and seems more like an aesthetic critique of the crass consumption choices of Americans rather than an actual economic argument. As Doug Henwood has noted, consumption spending includes things like health care and education spending, which are pretty non-discretionary and choices made by American families that very few people would probably begrudge.

But in another sense it’s even worse—the U.S. economy is not just dependent on consumption spending, it is more and more dependent on the consumption spending of the very rich,  which raises (at least) two problems. First, the rich have a lot more discretion over how much of the income they spend, so as more consumption spending is accounted for by the very top, large swings in this spending seem more possible. The upward whipsaw in the personal savings rate between the end of 2005 and middle of 2009, for example, was the largest since the Korean War mobilization. Second, are we really sure that the marginal consumption of the very rich yields an increase in total utility anywhere near as high as what could be gained if we instead taxed away an additional increment of very high incomes and spent it on, say public investment. Maybe aimed at mitigating greenhouse gas emissions, just to float one source?

I’ll end just by noting one way that the focus on inequality worries me: it threatens to crowd-out discussion of the policy lever we have in front of us that can solve today’s joblessness crisis. Simply put, austerity is the primary reason why the economy remains so depressed below 2007 levels of activity and employment today, four and a half years after the official end of the Great Recession. Nearly every component of demand-growth in the economy is actually at least in historic ranges of post-recession performance except for public spending, which is historically low, and which has decelerated markedly in the past two years. Reversing the generational growth in inequality is a necessary task, and will indeed make macroeconomic management easier. But it will take a long time and is a hugely complicated endeavor. Reversing austerity is much easier and will bear more immediate fruit, so let’s not let talk of inequality distract us from doing the (economically) easier things first.