by From James K. Galbraith and RWER no. 78 Could the economic program of President Donald Trump, if enacted, overcome secular stagnation? This essay addresses part of that question, focusing on the effects of a changing macroeconomic policy mix and thrust in the present US national and global context. A separate essay will address considerations on the supply side. The phrase “secular stagnation” is usually attributed to the early post-war Harvard economist Alvin Hansen, one of the first American disciples of John Maynard Keynes, who used it to argue that the American economy would return to the Great Depression once the Second World War ended. Today, secular stagnation is defined by Lawrence Summers, who defines it as the condition of a “low real neutral rate of interest”, or in Fed-speak a “low R* world”. A neutral rate of interest (“R*”) is said to be the one that neither increases nor restrains the economic growth rate. If such a rate exists and if it is close to zero, then monetary policy cannot spur growth, and a big-deficit fiscal policy is required. For this reason, it is argued, the great recession-cure of “Quantitative Easing”, so highly touted a few years back, proved to be mostly a dud. But fiscal policy would have better luck, whether through increased public spending or tax cuts, although only so long as the fiscal push is not offset by higher interest rates.
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from James K. Galbraith and RWER no. 78
Could the economic program of President Donald Trump, if enacted, overcome secular stagnation? This essay addresses part of that question, focusing on the effects of a changing macroeconomic policy mix and thrust in the present US national and global context. A separate essay will address considerations on the supply side.
The phrase “secular stagnation” is usually attributed to the early post-war Harvard economist Alvin Hansen, one of the first American disciples of John Maynard Keynes, who used it to argue that the American economy would return to the Great Depression once the Second World War ended. Today, secular stagnation is defined by Lawrence Summers, who defines it as the condition of a “low real neutral rate of interest”, or in Fed-speak a “low R* world”. A neutral rate of interest (“R*”) is said to be the one that neither increases nor restrains the economic growth rate. If such a rate exists and if it is close to zero, then monetary policy cannot spur growth, and a big-deficit fiscal policy is required.
For this reason, it is argued, the great recession-cure of “Quantitative Easing”, so highly touted a few years back, proved to be mostly a dud. But fiscal policy would have better luck, whether through increased public spending or tax cuts, although only so long as the fiscal push is not offset by higher interest rates. If interest rates rise, in a “low R* world” then the fiscal expansion will fail. This tension between fiscal and monetary forces is of great importance just now, as Donald Trump assumes the presidency on a program of infrastructure spending and tax cuts, while interest rates are starting to rise.
So, what do economists who argue along the lines described by Summers – a group that includes Paul Krugman, Ben Bernanke and other substantial figures – say that they think governs the interest rate? One might say: it’s obvious, Janet Yellen and Stanley Fischer decide the interest rate. But this is not what our leading economists appear to believe. Instead, they appear to believe – or anyway, they argue – that a panoply of natural and social forces lie behind the interest rate. And therefore, if interest rates rise to block the Trump expansion, it will be because those stars are aligned against him.
We have seen this movie before, in the early 1980s, when interest rates rose dramatically in advance of the Reagan tax cuts. Those high interest rates – reaching twenty percent briefly, and sustained at high levels for two years, generated a deep recession. They destroyed much of heavy industry in the Mid-west and of the trade union movement, previously the backbone of the Democratic Party. They were, in their way, the forebear of the economic conditions that have brought Donald Trump to power now.
In this paper I will first explore the intricate doctrines of the interest rate which are still circulating among high-profile economists, and which have the effect of obscuring a basic reality. The reality is that in the modern world of integrated global finance, the central bank of the largest economy determines the core financial conditions for the United States and also for the world at large. Whether a change in those conditions will serve, or undermine, the Trump program is the question. read more