On his blog yesterday, Paul Krugman somewhat rhetorically asks, among other questions, “What do we need to do to get the economy back on track?..."
I suspect he has his own views, but here is my quick answer before seeing his: We have several factors that seriously pull down aggregate demand in the U.S. relative to where it otherwise would be. We need to address them.
Here, I just list them:
- The serious maldistribution of income in the U.S. is a problem. The rich hoard and invest in secondary financial markets if they can't find original investment opportunities. Those with incomes over about $85,000 a year get about half of all U.S. income. The top 1/10 of one percent get six percent of all U.S. income. Unfortunately, the rich now have too much of the income of the U.S. and they spend proportionally less of it on consumption than others so aggregate demand falls.
- The high and rising productivity of the manufacturing sector and the offshore placement of work and jobs means that many more are unemployed or underemployed who were once in manufacturing because other sectors of the economy cannot fully absorb them. They spend less on consumption than before and aggregate demand falls.
- The on-going trade deficits mean Americans spend part of their disposable income on foreign goods. To the extent they cannot buffer that impact on their pocketbooks by debt, this reduces their demand for American goods and aggregate demand.
- Aggregate demand is also reduced by the wealth effect as the value of people's wealth and homes have dropped.
- As people decide that they need to save more and spend less to pay off or down their debt, that money is directed away from immediate consumption and aggregate demand again falls.
- To the extent there is rising unemployment and underemployment due to the Great Recession, which has arisen much more out of imbalances in stock variables, rather than flow variables per se, consumption and relative aggregate demand drop.
We need to address these problems directly and fix them. Simply engaging in deficit spending to pump aggregate demand is not going to do the trick because (1) it is expensive, sooner or later, and creates problems with stock variables and balance sheets, and (2) the impact on aggregate demand is transitory; there is a bump up and then aggregate demand largely falls back to where it would have been or close to it.
Deficit spending is no remedy in this kind of situation. It can be if there is a dip in aggregate demand from which we know a recovery will soon follow and we are simply trying to bridge the gap, but that is not our situation now. We are looking off the edges of a cliff.
America has no industrial policy, no serious trade policy and no notion even of an incomes policy. Our leadership is simply out to lunch on these scores, as economists squabble with one another over too much that really does not matter.
We need to formulate the policies we lack and focus on the issues I identify here, so as to fix them or develop mitigating solutions.
Disclosure: no postions
