We live amidst multi equilibria

November 2nd, 2015 at 8:46 am

Re the title of this post, that’s just a fancy way of saying that this notion that the economy is ever really at equilibrium seems pretty far off to me. Over at WaPo wherein I frame this from the perspective of inequality, i.e., the answer to the question “how’s the economy doing?” is “who’s economy you talkin’ about?”

Therein I cite an important new paper that’s been getting a lot of play–this one by Laubach and Williams (LW) which backs out the “natural rate of interest”–the interest rate that prevails when the economy’s in Goldilocks mode–not too hot, not too cold.

On the way to arriving at the natural rate of interest, the model spits out the potential growth rate, and that’s the part I show in the WaPo piece. It’s a very striking figure, showing “permanent damage” to our growth prospects not just over the Great Recession but over the recovery as well. Potential growth is in large part determined by “supply-side” variables, including the growth rate of productivity and the labor force. But they have been underperforming, especially productivity (part of the labor force decline is demographic; but part–I’d say at least a third–is weak demand).

But the thing you should note as you peruse LW’s key findings (e.g., figures 5 & 6) is that they move around a lot. Basically, in their model, the economy’s equilibria–the natural interest rate, potential GDP–is constantly changing. The same could be said of the alleged natural unemployment rate (the lowest unemployment rate consistent with stable inflation). No one really knows the true levels of these unobserved variables; we just back them out based on assumptions about their relationships with variables we can observe.

That’s a fine thing to do, up to a point, and LW’s results, for example, certainly pass a sniff test. Interest rates have been really low for really long and forward rates in markets suggest they’ll stay that way for awhile. Growth has decelerated, and, as noted, both productivity and labor force growth have been real slogs. I will say that chasing the “natural unemployment rate” does feel like a chimerical quest these days. The best move there is to let it keep falling until we see some damn wage/price growth.

But the larger point is that these “equilibria” are highly time-varying and not etched in stone. The labor force participation rate would likely grow at higher levels of demand, and I’ve argued there’s probably a full-employment productivity multiplier, a point Dean Baker usefully elaborated on in a recent post.

Something is blocking the private sector investment channel and, as I note in the piece, many economic scholars are pondering this puzzle–Brad DeLong provides an excellent rundown of their thinking here.

But here’s what I have to say about this (from my WaPo piece):

More pressing right now is what to do about it. The best answer I have is: If the private sector won’t generate the economic activity we need, the public sector must pick up the slack, as it were. Infrastructure investment in our deteriorating stock of public goods, direct job creation in places where jobs are nowhere to be seen even at low unemployment, quality pre-K for all 3-4 year-olds— all are great investment targets that I suspect would lower slack, raise the speed limit and improve distributional outcomes.

And…none will happen because of political constraints.

At the end of the day, the answer to the question “how’s the economy doing” is that it’s not doing near as well as it could be from the perspective of a lot of middle- and low-income people. And that’s not just an economic problem; it’s a political problem.

It so happens that there’s a contested election in the offing with lots of candidates gum-flapping about all of this. What I’m looking for is some version of this diagnosis and prescription. I haven’t heard it yet.

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2 comments in reply to "We live amidst multi equilibria"

  1. urban legend says:

    Someone on the leftward side of things has to decide that we are going to do everything possible for as many years or decades as it takes to make a complete transformation in the willingness of people to vote. So long as we acquiesce in the belief that mid-term elections will not generate more than a 35% or so turnout, and that even Presidential elections will be lucky to get much above a simple majority of the voting age population, nothing much will change. Change requires the will to make it happen and the determination to persist for years and years despite setbacks. The goal should be 100% in all elections, but let’s settle for interim goals of 65% in 2016 and 50% in the 2018 mid-terms.

    The only way it is going to happen is to change attitudes: to convince those who tend not to vote that politicians need two things, money and votes, and when they don’t bother to vote, they guarantee that the billionaires with the big money will get what they want out of government. That when ethnic groups don’t vote, they guarantee that their interests will take second (or third or fourth) place. The only weapon the people have against politicians being dominated by the people with the most money is the vote. These kinds of messages need to be repeated over and over and over in every possible medium — TV, print, new media — for as long as it takes to get our voting patterns at least up to the standard of other major countries.

    Who will do that? Everyone’s focused on helping individual candidates, but nothing would help Democrats (and progressives) them more than a quantum increase in turnout. The official Democratic organizations (DNC, DSCC and DCCC) totally stink at any kind of brand promotion — such as the incontrovertible national need to drive as many current Republicans out of office at every level as possible, even the ones who purport to be moderate or “decent” but who nevertheless will not break with Norquist-Speaker-Hastert Ruole party discipline.

    The ones who can and should do it — and concentrate and pool their resources to do it — are the major progressive organizations. Nothing will help progressive candidates — and help push wishy-washy Democrats in a more progressive direction — than a huge increase in turnout. Let the official organizations learn to sell the Democratic brand and help all Democrats who need it. Let the progressive organizations with strong memberships and good money combine to launch the campaign to drive the new direction on turnout. That’s the recipe for turning things around.

  2. Nick Estes says:

    “And…none will happen because of political constraints.” One of the biggest of these constraints is that people (including good liberals) are so afraid of running up our national debt that they are scared of the deficit spending that would fix our infrastructure, reduce unemployment, and put some upward pressure on wages. I’m going to say again that I see no reason why we should not get the Fed to simply mark up the Treasury’s spending account by the amount of the deficit. There is no reason why the Treasury should have to borrow this money and increase the national debt. Some day this is the way we will do it–at least if we start talking about it now. Let people howl about hyper-inflation and the horrors of “printing money.” It’s time for people to begin to learn that printing money in moderation is not a bad thing to do to plug the spending gap you are talking about.