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.