My son has been home from college for a month now. It’s nice having him around; he’s become a much more interesting young man in the last year. He and his little sister have had only a handful of the pitched battles that came almost hourly a year ago. And he has been very helpful when heavy lifting is required, which my back appreciates.
But my son has been less than fully industrious so far this summer. Wake-up time has extended past noon on many days, and “floor” seems to be a synonym for “hamper” in his mind. I recently suggested that he pick up the pace a little bit, lest he be unprepared for the demands of his sophomore year. “Don’t worry,” he said, “my current stagnation is cyclical and not secular.”
While this was a cheeky response, I nonetheless give him credit for using terms that I understand. The question of stagnation is one that economists have recently been giving a great deal of thought. Understanding what accounts for recent underperformance is critical to setting policy that might address it.
The recovery which began in 2009 has been weak and uneven. Some have blamed scarring from the financial crisis: wounds to the balance sheets of households, banks, and governments are taking a long time to heal. Under this school of thought, returning to pre-crisis normalcy is simply a matter of time, with the mending promoted by accommodative monetary policy. If the strategy works, we’ll eventually return to the 3% real growth that we’ve averaged over the past generation.
But others have vocally challenged this conventional wisdom. Led by former U.S. Treasury Secretary Larry Summers, contrarians have suggested that recent results have only been achieved because of progressively lower levels of real interest rates that have masked underlying deterioration in potential. Low rates have had the side effect of creating excesses of credit which proved unsustainable. And now that we’ve reached the zero lower bound, our ability is very limited to shock the economy back to 3% with monetary policy.
The “secular stagnation” camp sees roots of the phenomenon on both the demand side and the supply side of the economy. Income inequality was increasing long before the Great Recession, with the decades-old expansion of international trade among the main catalysts. Higher-income households have lower propensities to spend. So when earnings gains accrue more quickly to those who are already wealthy, aggregate consumption growth slows and a savings glut forms.
On the supply side, there appear to be two limitations. The first is demographic. Developing countries are getting collectively older; birth and immigration rates have struggled to compensate for the retirement of postwar generations. Older populations are less aggressive with their investments, start fewer companies and are granted fewer patents. Aging countries also devote more funds to pension and health benefits, resources which might otherwise be applied to investments in human and physical capital.
The second is productivity, which has experienced a gradual secular decline that began long before 2008. This could be the result of modest levels of public and private investment in research, development and capital. And there are also observers who think that returns on such investments are diminishing. Robert Gordon of Northwestern University has suggested that big ideas are arising less frequently and that the benefits of innovation dissipate much more quickly.
While there are certainly those who take issue with the latter perspective, it is also certainly true that the level of investment in productive capacity has been very modest during the expansion to date. In the public sector, fiscal contraction has slowed upgrades to physical and technological infrastructure. In the private sector, firms seem to prefer using their hordes of cash to buy back shares or engage in acquisitions that produce cost synergies, instead reinvesting in their operations.
Monetary policy continues to aim at easing limitations on both supply and demand but may be creating risks for financial stability down the road. Further, some of the root causes of secular stagnation might better be addressed with other types of policies. These might include incentives for experienced workers to remain in the labor force longer, increased public investment in infrastructure and education, tax credits for research and development, and immigration reforms.
In these austerity-driven times, programs that might increase short-term deficits are viewed with a jaundiced eye. But a few line items on the ledger are investments and not costs. They will, in the long run, produce revenues that will make them budget-neutral or positive. The alternative is to simply accept that potential growth is going to grind lower over the coming decades. That path could have significant and negative implications for public and private finances… and for our children.
I do take comfort from the fact that the first mention of secular stagnation came in 1939, just before the United States began several decades of very strong growth. There is precedent for new forces to combine with economic adaptation to put us on a better track. But we must take assertive steps today to avoid a stagnant tomorrow. Or so I’ve told my son.
The U.S. Expansion at Five Years Old
June marks the fifth anniversary of the current business expansion in the United States. It is an important milestone because the average duration of post-war expansions in this country is 58 months. For sheer longevity, the current expansion now belongs to the above-average club. But by many other measures, the current phase has generally been disappointing. Why has it been this way, and where might it go from here?
Real gross domestic product (GDP) is the best aggregate economic measure to assess the standing of the recovery relative to its post-war peers. Over the first 19 quarters since the recession ended in mid-2009, real GDP has advanced 10% from its trough. By contrast, in post-war cycles of similar age, real GDP moved up by an average of 23%. And the United States should feel fortunate. The latest research of Reinhart and Rogoff concludes that the United States and Germany are the only two countries that experienced a systemic crisis in 2007-08 to record an increase in real per-capita GDP that exceeds the peak of the previous cycle.
Consistent with the modest increase in real GDP, employment data have been unimpressive. Payroll employment in the United States has risen only 5.3% from the trough in June 2009, while there was a 13% increase, on average, in hiring during other long expansions of the post-war period. Recent readings showed better momentum, however, so prospects are good that this gap may begin to close in the quarters ahead.
The resulting lack of meaningful growth in wages also is illustrated well by a broad historical context. The wages and salaries component of personal income shows the smallest increase after 19 quarters of growth across the last six long business cycles. This trend has to turn around, lest it continue to bear negatively on aggregate demand in the economy. Consumer spending has risen by only 10.8% after 19 quarters of expansion and bears the dubious distinction of being the smallest increase across all long business cycles in the last 55 years. Along the same lines, residential investment has risen by 28% in the last 19 quarters, far short of the 45% increase seen during other recoveries of similar duration.
The financial crisis forced many households to deleverage, a trend which has certainly hindered spending. Encouragingly, ratios of household debt to household income in the United States have fallen back to levels not seen since the early 2000s, suggesting that there may be a little more budget for spending in the years ahead.
Budget stress has also limited activity in the public sector during the recent expansion. Federal government outlays rose significantly to offset the collapse in private-sector demand following the financial crisis. However, fiscal consolidation since then has resulted in a large reduction in federal government outlays to the extent that it shows a nearly 8% decline at the end of 19 quarters of economic recovery. The 1991-2001 expansion also showed a drop in federal government spending, but it reflected a federal budget surplus under favorable economic circumstances.
The reduction of state and local government spending (a larger component of GDP compared with the federal government component) during the expansion is a new record. The decline in overall government spending much before strong private sector demand was in place bears some of the responsibility for the recovery’s weakness. Encouragingly, though, the outlook for the public sector has brightened considerably, and most analysts expect it to go from a drag to a driver of GDP growth in the quarters ahead.
Given the nature of the financial crisis, it should not be surprising that bank lending recorded a sharp contraction even after the recovery commenced. At the deepest phase, bank lending had fallen nearly 13% from 2008 levels. The Troubled Asset Relief Program and an intensive effort to clean up and strengthen balance sheets of banks resulted in a noteworthy turnaround. Bank lending is once again growing at a noticeable pace, but the level of bank lending is likely to take a few more quarters to surpass the peak seen in the previous cycle.
So as we pause to assess the performance of the economy based on fundamentals, the current U.S. recovery carries a below-average rank. But maybe this is the best we might have expected. According to Reinhart and Rogoff, history dictates that a full economic recovery (measured by restoration of pre-crisis income levels) takes, on average, about eight years after a severe financial crisis.
The good news is that we have covered a good part of this distance, and cyclical factors should be supportive of better outcomes going forward. If policy can address the structural challenges discussed in our opening segment, this expansion could yet meet the standard of its predecessors.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.