FED Vice Chairman Stanley Fischer spoke at the “Policy Challenges in an Interconnected World” Conference. In his speech, “Reflections on Macroeconomics Then and Now“, he highlighted some of the macroeconomic uncertainties which beset the economy.
I would like briefly to take up several topics in more detail. Some of them are issues that have remained central to the macroeconomic agenda over the past 50 years, some have to my regret fallen off the agenda, and others are new to the agenda.
- Inflation and unemployment: Estimated Phillips curves appear to be flatter than they were estimated to be many years ago–in terms of the textbooks, Phillips curves appear to be closer to what used to be called the Keynesian case (flat Phillips curve) than to the classical case (vertical Phillips curve). Since the U.S. economy is now below our 2 percent inflation target, and since unemployment is in the vicinity of full employment, it is sometimes argued that the link between unemployment and inflation must have been broken. I don’t believe that. Rather the link has never been very strong, but it exists, and we may well at present be seeing the first stirrings of an increase in the inflation rate–something that we would like to happen.
- Productivity and growth: The rate of productivity growth in the United States and in much of the world has fallen dramatically in the past 20 years. The table shows calculated rates of annual productivity growth for the United States over three periods: 1952 to 1973; 1974 to 2007; and the most recent period, 2008 to 2015. After having been 3 percent and 2.1 percent in the first two periods, the annual rate of productivity growth has fallen to 1.2 percent in the period since the start of the global financial crisis.The right guide to thinking in this case is given by a famous Herbert Stein line: “The difference between a growth rate of 1 percent and 2 percent is 100 percent.” Why? Productivity growth is a major determinant of long-term growth. At a 1 percent growth rate, it takes income 70 years to double. At a 2 percent growth rate, it takes 35 years to double. That is to say, that with a growth rate of 1 percent per capita, it takes two generations for per capita income to double; at a 2 percent per capita growth rate, it takes one generation for per capita income to double. That is a massive difference, one that would very likely have severe consequences for the national mood, and possibly for economic policy. That is to say, there are few issues more important for the future of our economy, and those of every other country, than the rate of productivity growth.At this stage, we simply do not know what will happen to productivity growth.Robert Gordon of Northwestern University has just published an extremely interesting and pessimistic book that argues we will have to accept the fact that productivity will not grow in future at anything like the rates of the period before 1973. Others look around and see impressive changes in technology and cannot believe that productivity growth will not move back closer to the higher levels of yesteryear.7 A great deal of work is taking place to evaluate the data, but so far there is little evidence that data difficulties account for a significant part of the decline in productivity growth as calculated by the Bureau of Labor Statistics.
- The ZLB and the effectiveness of monetary policy: From December 2008 to December 2015, the federal funds rate target set by the Fed was a range of 0 to 1/4 percent, a range of rates that was described as the ZLB (zero lower bound).9 Between December 2008 and December 2014, the Fed engaged in QE–quantitative easing–through a variety of programs. Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.Critics have argued that QE has gradually become less effective over the years, and should no longer be used.It is extremely difficult to appraise the effectiveness of a program all of whose parameters have been announced at the beginning of the program. But I regard it as significant with respect to the effectiveness of QE that the taper tantrum in 2013, apparently caused by a belief that the Fed was going to wind down its purchases sooner than expected, had a major effect on interest rates.More recently, critics have argued that QE, together with negative interest rates, is no longer effective in either Japan or in the euro zone.That case has not yet been empirically established, and I believe that central banks still have the capacity through QE and other measures to run expansionary monetary policies, even at the zero lower bound.
- The monetary-fiscal policy mix: There was once a great deal of work on the optimal monetary-fiscal policy mix. The topic was interesting and the analysis persuasive. Nonetheless the subject seems to be disappearing from the public dialogue; perhaps in ascendance is the notion that–except in extremis, as in 2009–activist fiscal policy should not be used at all. Certainly, it is easier for a central bank to change its policies than for a Treasury or Finance Ministry to do so, but it remains a pity that the fiscal lever seems to have been disabled.
- The financial sector: Carmen Reinhart and Ken Rogoff’s book, This Time Is Different, must have been written largely before the start of the great financial crisis. I find their evidence that a recession accompanied by a financial crisis is likely to be much more serious than an ordinary recession persuasive, but the point remains contentious. Even in the case of the Great Recession, it is possible that the U.S. recession got a second wind when the euro-zone crisis worsened in 2011. But no one should forget the immensity of the financial crisis that the U.S. economy and the world went through following the bankruptcy of Lehman Brothers–and no one should forget that such things could happen again.The subsequent tightening of the financial regulatory system under the Dodd-Frank Act was essential, and the complaints about excessive regulation and excessive demands for banks to hold capital betray at best a very short memory.We, the official sector and particularly the regulatory authorities, do have an obligation to try to minimize the regulatory and other burdens placed on the private sector by the official sector–but we have a no less important obligation to try to prevent another financial crisis. And we should also remember that the shadow banking system played an important role in the propagation of the financial crisis, and endeavor to reduce the riskiness of that system.
- The economy and the price of oil: For some time, at least since the United States became an oil importer, it has been believed that a low price of oil is good for the economy. So when the price of oil began its descent below $100 a barrel, we kept looking for an oil-price-cut dividend. But that dividend has been hard to discern in the macroeconomic data. Part of the reason is that as a result of the rapid expansion of the production of oil from shale, total U.S. oil production had risen rapidly, and so a larger part of the economy was adversely affected by the decline in the price of oil. Another part is that investment in the equipment and structures needed for shale oil production had become an important component of aggregate U.S. investment, and that component began a rapid decline. For these reasons, although the United States has remained an oil importer, the decrease in the world price of oil had a mixed effect on U.S. gross domestic product. There is reason to believe that when the price of oil stabilizes, and U.S. shale oil production reaches its new equilibrium, the overall effect of the decline in the price of oil will be seen to have had a positive effect on aggregate demand in the United States, since lower energy prices are providing a noticeable boost to the real incomes of households.
- Secular stagnation: During World War II in the United States, many economists feared that at the end of the war, the economy would return to high pre-war levels of unemployment–because with the end of the war, demobilization, and the massive reduction that would take place in the defense budget, there would not be enough demand to maintain full employment.Thus was born or renewed the concept of secular stagnation–the view that the economy could find itself permanently in a situation of low demand, less than full employment, and low growth.10 That is not what happened after World War II, and the thought of secular stagnation was correspondingly laid aside, in part because of the growing confidence that intelligent economic policies–fiscal and monetary–could be relied on to help keep the economy at full employment with a reasonable growth rate.Recently, Larry Summers has forcefully restated the secular stagnation hypothesis, and argued that it accounts for the current slowness of economic growth in the United States and the rest of the industrialized world. The theoretical case for secular stagnation in the sense of a shortage of demand is tied to the question of the level of the interest rate that would be needed to generate a situation of full employment. If the equilibrium interest rate is negative, or very small, the economy is likely to find itself growing slowly, and frequently encountering the zero lower bound on the interest rate.
Research has shown a declining trend in estimates of the equilibrium interest rate. That finding has become more firmly established since the start of the Great Recession and the global financial crisis. Moreover, the level of the equilibrium interest rate seems likely to rise only gradually to a longer-run level that would still be quite low by historical standards.
What factors determine the equilibrium interest rate? Fundamentally, the balance of saving and investment demands. Several trends have been cited as possible factors contributing to a decline in the long-run equilibrium real rate. One likely factor is persistent weakness in aggregate demand. Among the many reasons for that, as Larry Summers has noted, is that the amount of physical capital that the revolutionary information technology firms with high stock market valuations have needed is remarkably small. The slowdown of productivity growth, which as already mentioned has been a prominent and deeply concerning feature of the past six years, is another important factor.12 Others have pointed to demographic trends resulting in there being a larger share of the population in age cohorts with high saving rates.13 Some have also pointed to high saving rates in many emerging market countries, coupled with a lack of suitable domestic investment opportunities in those countries, as putting downward pressure on rates in advanced economies–the global savings glut hypothesis advanced by Ben Bernanke and others at the Fed about a decade ago.
Whatever the cause, other things being equal, a lower level of the long-run equilibrium real rate suggests that the frequency and duration of future episodes in which monetary policy is constrained by the ZLB will be higher than in the past. Prior to the crisis, some research suggested that such episodes were likely to be relatively infrequent and generally short lived.15 The past several years certainly require us to reconsider that basic assumption. Moreover, recent experience in the United States and other countries has taught us that conducting monetary policy at the effective lower bound is challenging.16 And while unconventional policy tools such as forward guidance and asset purchases have been extremely helpful and effective, all central banks would prefer a situation with positive interest rates, restoring their ability to use the more traditional interest rate tool of monetary policy.
The answer to the question “Will the equilibrium interest rate remain at today’s low levels permanently?” is also that we do not know. Many of the factors that determine the equilibrium interest rate, particularly productivity growth, are extremely difficult to forecast. At present, it looks likely that the equilibrium interest rate will remain low for the policy-relevant future, but there have in the past been both long swings and short-term changes in what can be thought of as equilibrium real rates.
Eventually, history will give us the answer. But it is critical to emphasize that history’s answer will depend also on future policies, monetary and other, notably including fiscal policy.
