And yet, outside of wartime, we’ve never had so much fiscal stimulus at such low unemployment. The unemployment rate is 3.7 percent and the budget deficit as a share of GDP is -4.2 percent. Based on the proposed budget deal — also financed by deficit spending — the federal government is about to add another $320 billion in new debt over the next two years (about 0.7 percent of GDP). Historically, when unemployment has been this low, the average deficit/GDP ratio has been about zero.
Monetary policy is about to add to the stimulus, as the Federal Reserve is widely expected to cut the benchmark interest rate at its meeting next week. To lower the cost of borrowing and boost investment, the Fed lowers the benchmark interest rate it controls. Based on concerns about the stability of current conditions, it’s planning what Fed watchers have labeled an “insurance cut,” meaning a cut to ensure the economy doesn’t deteriorate beyond those forecasts noted above. Historically, the average unemployment rate when the Fed has started a rate-cut cycle has been 6.5 percent, almost 3 points above today’s rate.
In other words, in the past, whenever the government has spent this much borrowed money and the Fed has reduced rates, the economy has been in much worse shape than it is today. Why does an economy that looks strong by some indicators need so much help?
In fact, there are important ways in which the economy is less strong than the jobless rate suggests. One can jam the pedal to the metal all day, but if the roads are blocked, your car won’t hit top speed. Here are a set of reasons it might take a lot more stimulus these days just to keep the current expansion trundling along.
Increased inequality: The intersection of two facts make income inequality a prime suspect. First, about 70 percent of the U.S. economy is made up of consumer spending, a much higher share than in Europe (about 55 percent). Second, the richer you are, the more likely you are to save as opposed to spend. Thus, if “too much” of an economy’s income goes to a narrow sliver of people with a higher propensity to save than to spend — I’m talking to you, top 1 percent! — that can be a drag on economic activity.
Trade deficits: Trade imbalances — more imports than exports — are, by definition, a drag on growth, but that doesn’t mean they’re always a problem, contrary to what President Trump appears to believe. After all, if we’re doing better than our trading partners, we’re sure to pull in more of their imports and sell them fewer of our exports. But the United States has run economically significant trade deficits since the mid-1970s, and that’s partly the result of outsourcing of a lot of economic activity, especially in manufacturing, that’s now happening “there” instead of “here.”
Interest rates bound by zero: One of the cool things about flexible economies like ours is that they can, at least in theory, handily respond to problems such as higher inequality and trade deficits by adjusting key parameters like the cost of credit. The problem is that interest rates, which have been historically very low in recent years, are bound at the low end by zero (yes, the European Central Bank is trying negative rates, where lenders weirdly pay borrowers, but our Federal Reserve doesn’t want to go there). So, because rates are already so low without much room to fall, the traditional tools provide less adjustment assistance.
Neutral fiscal impulse: You know that new, deficit-financed budget deal I cited above? You might think that $320 billion package would help give the 2020-21 economy a sizable jolt. But you’d be wrong. The problem is that what tweaks the economy’s growth rate isn’t just another big spending deal; it’s another, big spending deal that’s bigger than the last one. Earlier spending packages increased the level of government spending, and thereby juiced the growth rate. This one holds government spending steady, and so it’s neutral in terms of the growth rate.
The low-capital economy: Economist Larry Summers has long discussed this growth problem under the rubric of “secular stagnation.” Part of the case he makes is that there’s just going to be significantly less investment in an economy where we buy stuff online versus at the mall (though, believe it or not, e-commerce is still just 10 percent of retail sales; still, it’s climbing fast, which is what matters here) and where our biggest, fastest growing firms don’t buy factories and big machines but write code (or, more to the point, outsource code-writing). The new economy, Summers writes, “tends to conserve capital.”
Just downright bad policy: Yes, long-term forces like inequality, low rates and shifting capital needs are in play, but a good chunk of this underlying weakness comes from policies that kick the ball in our own goal. The Trump administration’s trade war is exhibit A, but a lot of other policies hurt too, such as barring immigrants and other bouts of racism, alienating our global partners, exacerbating inequality through regressive tax cuts, and failing to invest in public goods from health care to education to infrastructure to climate mitigation.
Surely that last observation shows the way forward. Given the forces aligned against growth and the inability of already low interest rates to fall far enough to facilitate the necessary adjustment, we simply can’t afford the luxury of such harmful policies. That, in turn, means the economic problem requires a political solution, as in much smarter policymakers.
If only a big election were forthcoming.