Faster Growth IS Possible - And It May Well Be Desirable
Professor Gerald Friedman has argued here that, by adopting Senator Bernie Sanders’ economic proposals, the US economy would grow in excess of 5% per year over the next decade. Previously, former Governor Jeb Bush put forward (different) proposals that he has argued would lead to 4% economic growth over an extended period. These kinds of growth outcomes are often dismissed as prima face unachievable given the historical behavior of the US economy. (That’s one way that some readers have interpreted this letter.)
I don't attempt a full examination of Senator Sanders' or Mr. Bush's proposals in this post. Rather, I make three points related to this discussion that don't receive sufficient attention:
My first point is familiar to all economists. Technologically speaking, the US can grow much faster over the next ten years than is currently forecast if two changes take place. The first is that Americans allocate a much larger share of expenditures than is forecast to physical investment (like hospitals or housing) as opposed to current consumption. The second change is that Americans work a lot more hours in ten years' time than is forecast. (Of course, the super-normal growth will be followed by sub-normal growth unless these changes are sustained over time.) Neither of these changes change is in any way technologically impossible. The question is whether they are desirable or not.
With that in mind, my second point is about the benefits versus the costs of a higher growth path. Economists often attempt to answer this question by referring only to the historical time series behavior of quantities (like GDP or employment). But it’s a cost-benefit question - we surely have to use market prices. The behavior of the relevant prices is without precedent in the post-World War II period.
For example, the real interest rate is very low (and, even so, still seems to be too high to be consistent with full resource utilization). This price signal suggests that Americans are willing to give up a lot of current resources for the promise of certain future resources - that is, they seem unusually willing to forego consumption for growth. In terms of employment, wages remain unprecedentedly low relative to (average) worker productivity. This price signal suggests that there may be large net social benefits available associated with drawing many more Americans into the labor market.
My third point is about the right policy steps to take in order to achieve a higher growth path. Here, again, the macroeconomic circumstances matter. If the Fed and other central banks were well away from the zero lower bound, then I would be more favorably inclined to incentive-based supply-side interventions as the best way forward. But that’s not the situation. Around the world, aggregate demand remains low. In Larry Summers’ words, aggregate demand interventions like physical infrastructure investment may not be free lunches - but they certainly seem like cheap lunches.
To sum up: above-normal growth is always possible. The current data on market prices like interest rates and wages suggest that above-normal growth might well be desirable. The ongoing constraints on monetary policy suggest that we can best achieve that faster growth through demand-oriented policies.
N. Kocherlakota
Rochester, NY, February 18, 2016
Please address media enquiries and non-academic speaking requests to Monique Patenaude (monique.patenaude@rochester.edu and 585-276-3693).