Scott Sumner writes “What kind of Great Stagnation?”
It seems to me that the Krugman/Summers view has three big problems:
- The standard textbook model says demand shocks have cyclical effects, and that after wages and prices adjust the economy self-corrects back to the natural rate after a few years. Even if it takes 10 years, it would not explain the longer-term stagnation that they believe is occurring.
- Krugman might respond to the first point by saying we should dump the new Keynesian model and go back to the old Keynesian unemployment equilibrium model. But even that won’t work, as the old Keynesian model used unemployment as the mechanism for the transmission of demand shocks to low output. If you showed Keynes the US unemployment data since 2009, with the unemployment rate dropping from 10% to 6.1%, he would have assumed that we had had fast growth. If you then told him RGDP growth had averaged just over 2%, he would have had no explanation. That’s a supply-side problem. And it’s even worse in Britain, where job growth has been stronger than in the US, and RGDP growth has been weaker. The eurozone also suffers from this problem.
The truth is that we have three problems:
- A demand-side (unemployment) problem that was severe in 2009, and (in the US) has been gradually improving since.
- Slow growth in the working-age population.
- Supply-side problems ranging from increasing worker disability to slower productivity growth
Likely all those things are true. But why? I posit that the demand shock was so severe (and long lasting) that it greatly helped mess up the supply side. That means that now, the previous level of activity is not attainable (at least for a long time). The charts indicate that all those supply side factors went “off” after the “Great(demand shock)Recession” hit, a consequence of the Fed´s (and many other central banks) “Great Monetary Policy Mistake” of 2008.
The next chart indicates that the economy, even given the supply side “negatives”, could be at a higher level of activity. Closing a $1.7 trillion gap through, say, an NGDP Level Target not allowing all bygones be bygones would also do “wonders” for the supply side!