Is the Only Choice Bubbles or Recession?
The Onion, a satirical newspaper, ran one of its best headlines ever in July 2008: "Recession-Plagued Nation Demands New Bubble to Invest In." More than five years later, this joke resembles a serious suggestion from several of the world's leading economists. That would leave us with an unappetizing choice between the excesses of the go-go years and chronic slow growth and underemployment. Fortunately, there may be an alternative -- if we're willing to do something about wealth and income inequality.
During a presentation at the International Monetary Fund's most recent economic forum, Larry Summers, the former Treasury secretary, argued that we should be concerned about policies "whose basic purpose is to cause there to be less lending, borrowing, and inflated asset prices than there was before." To economist Paul Krugman, what Summers seemed to be saying is that tougher financial regulation "may discourage irresponsible lending and borrowing at a time when more spending of any kind is good for the economy." It's a view that Krugman endorses and is reminiscent of his suggestion in 2002 that the Fed engineer a housing bubble to offset the collapse in business investment.
Although this may sound like foolishness, parts of their argument are compelling. In spite of too much investment in real estate and business capacity in the 1980s, 1990s and 2000s, conventional metrics suggest that the U.S. economy never overheated. Adjusted for population, real gross domestic product has grown more slowly in the past three decades than it did in the 30 years after the end of the Korean War. Price increases for goods and services have been stable and subdued since the mid-1980s. There were fewer Americans working in the private sector in May 2005 than in December 2000. Growth might have been even more tepid had there been no irrational exuberance.
The simplest explanation is that there haven't been enough productive investment opportunities relative to the world's total desire to save. According to this view, bubbles can transform wealth that would otherwise be stashed in government bonds and other safe assets into income for those who work in the expanding parts of the economy.
At least some of that newly created income would get spent and, for a little while, the economy would be boosted closer to full employment. (It's unclear whether this is a sustainable strategy.) This reasoning has led several Fed officials to embrace negative real interest rates in the hope that the threat of wealth confiscation will force cautious savers to either consume more of their wealth or bet on the next bubble, wherever it may be.
This analysis is deeply dissatisfying. Yes, in the aggregate, today's interest rates are too high to encourage the spending necessary to restore full employment. But monetary policy is a blunt instrument, and aggregates are misleading.
Few Americans have enough savings to cover the cost of retirement, and less than a quarter have enough set aside to meet six months of expenses. Although the share of U.S. household wealth held in safe liquid assets has increased since 2007, it is still much lower than in the mid-1980s. Let's also not forget that the poorer and more indebted households that boosted their spending the most when house prices were going up were also forced to cut their spending the most during the subsequent downtown. In other words, the newfound desire to save is completely natural and should be encouraged, rather than penalized.
It seems more likely that the real problem is the dramatic concentration of wealth and incomes during the past 30 years. Those who have much more than they can ever hope to spend don't increase their consumption by much when their incomes increase. Instead, they tend to save the extra dollars. Many others tried to compensate for their stagnant incomes by borrowing more and more. That enabled spending but created the danger of excess indebtedness.
One solution would be for the government to expand its existing role as a financial intermediary. It could sponsor special savings accounts that would be protected against inflation but limited in size, as Steve Randy Waldman has suggested. Anyone who wanted to hold additional safe assets could always buy bonds, although those wouldn't be protected against inflation. Meanwhile, the government could disburse direct cash payments to households to reinvigorate a weakened economy (like now). This combination would enable regular people to spend without incurring too much debt and save without having to worry about the threat of wealth confiscation through deflating bubbles or negative rates. This might be a better deal than the current suggestions on offer.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)