Meeting America’s Growth Challenge

Laura Tyson

30 January 2013


BERKELEY The United States continues to recover from its deepest economic slump since the Great Depression, but the pace of recovery remains frustratingly slow. There are several reasons to anticipate modest improvement in 2013, although, as usual, there are downside risks.

Prolonged recession or a financial crisis in Europe and slower growth in emerging markets are the main external sources of potential danger. At home, political infighting underlies the two greatest risks: failure to reach a deal to raise the debt ceiling and an additional round of fiscal contraction that stymies economic growth.
Since 2010, tepid average annual GDP growth of 2.1% has meant weak job creation. In both this recovery and the previous two, the rebound in employment growth has been weaker and later than the rebound in GDP growth. But the loss of jobs in the most recent recession was more than twice as large as in previous recessions, so a slow recovery has meant a much higher unemployment rate for a much longer period.
Weak aggregate demand is the primary culprit for subdued GDP and employment growth. The 2008 recession was triggered by a financial crisis that erupted after the collapse of a credit-fueled asset bubble decimated the housing market. Private-sector demand contracts sharply and recovers only slowly after such crises. The private-sector financial balance swung from a deficit of 3.7% of GDP in 2006, at the height of the boom, to a surplus of about 6.8% of GDP in 2010 and about 5% today. This represents the sharpest contraction and weakest recovery in private-sector demand since the end of World War II. 
Growth in two components of private demand, residential investment and consumption, which account for more than 75% of total spending in the US economy, has been especially slow. Both sources of demand are likely to strengthen in 2013..
Residential investment is still at an historic low as a share of GDP as a result of overbuilding during the 2003-2008 housing boom and the tsunami of foreclosures that followed. But the headwinds in the housing market are dissipating.

Home sales, prices, and construction all rose last year, while foreclosures declined. Residential investment should be a source of output and job growth this year. 
Large losses in household wealth, deleveraging from unsustainable debt, weak wage growth, and a decline in labor’s share of national income to a historic low have combined to constrain consumption growth. Real median household income is still nearly 7% below its 2007 peak, real median household net worth dropped by 35% between 2005 and 2010 (and remains significantly below its pre-recession peak), and about 90% of the income gains during the recovery have gone to the top 1%. 

To be sure, the balance-sheet headwinds holding back consumption have eased. Households have slashed their debtoften through painful foreclosures and bankruptcies – and their debt relative to income has sunk to its 2005 level, significantly below its 2008 peak. Helped by low interest rates, debt service relative to household income has fallen back to levels not seen since the early 1980’s. But consumption will be hit by the expiration of the payroll tax cut, which will reduce household income by about $125 billion this year..
Another factor holding back recovery has been weak growth in spending on goods and services by both state and local governments, and more recently by the federal government. Indeed, since the recession’s onset, state and local governments have cut nearly 600,000 jobs and reduced spending for infrastructure projects by 20%..
The fiscal trends for 2013 are mixed, but negative overall. While state and local government cutbacks in spending and employment are ending as the recovery boosts their tax revenues, the fiscal drag at the federal level is strengthening.

The American Taxpayer Relief Act – the tax deal reached in early January to avoid the “fiscal cliff” – shaves about $750 billion from the deficit over the next ten years and could take a percentage point off the 2013 growth rate. In addition, although less widely appreciated, significant reductions in federal spending are already under way, with more likely to come..
Spending cuts and revenue increases that have been legislated since 2011 will reduce the projected deficit by $2.4 trillion over the next decade, with three-quarters coming from spending cuts, almost exclusively in non-defense discretionary programs. Based on current economic assumptions, the US needs about $4 trillion in savings to stabilize the debt/GDP ratio over the next decade. It is already three-fifths of the way there. 
The so-called sequester (the across-the-board spending cuts scheduled to begin in March), would slash another $100 billion this year and $1.2 trillion over the next decade. Although it could stabilize the debt/GDP ratio, the sequester would be a mistake: it fails to distinguish among spending priorities, would undermine essential programs, and would mean another significant dent in growth this year. 
Moreover, despite the warnings of deficit alarmists, the US does not face an imminent debt crisis. Currently, the federal debt held by the public is just over 70% of GDP, a level not seen since the early 1950’s. However, government debt soars by an average of 86% after severe financial crises, so the increase in the federal debt by 70% between 2008 and 2012 is not surprising. 
Nor is it alarming. The US economy grew rapidly for several years after WWII with a higher debt/GDP ratio, and today’s ratio is lower than in all other major industrial countries (and roughly half that of Greece, analogies to which are absurd and misleading). 
During the last two years, Washington has been obsessed with the need to cut the deficit and put the debt/GDP ratio on a “sustainable path, even as global investors have flocked to US government debt, driving interest rates to historic lows. The considerable progress that has been made on deficit reduction over the next ten years has been overlooked. Also overlooked have been the immediate challenges of low growth, weak investment, and high unemployment. 
It is time to refocus. The US needs a plan for faster growth, not more deficit reduction. Evsey Domar, a legendary growth economist (and one of my MIT professors) counseled that the problem of alleviating the debt burden is essentially a problem of achieving growth in national income. We should heed his wisdom. 

Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley.
Copyright Project Syndicate -

Markets Insight

January 30, 2013 11:30 am
Central banks walk inflation’s razor edge
Monetary policy should look to the long term

The exteriors of major central banks may be solid marble and doric columns, but inside, monetary policy remains a work in progress. Those inside have to craft a policy framework that makes the most efficient use of instruments of varying potential effectiveness and show responsiveness, but not subservience, to external political pressures.

Of late, the changes have come at a dizzying pace in a culture that usually measures regime shifts in terms of generations. In just a few months, we welcome a new governor at the Bank of England, a new communications policy at the Federal Reserve, and a new determination at the Bank of Japan to hit a higher inflation target.

Not all change, though, represents progress. Of particular concern is the increasing desire of officials to tie monetary policy to real outcomes. This is best exemplified by the instructions handed down on January 11 by Shinzo Abe, the prime minister of Japan: “We would like the BoJ to take responsibility for the real economy. I think that means jobs. I would like the BoJ to think about maximising jobs.”

The Fed’s setting of a threshold for the unemployment rate, and the suggestion that the UK adopt a nominal income target, whereby real output growth and inflation get equal weights, go in the same direction.

The impetus behind this trend is understandable. The recovery from the financial crisis has been disappointing, and resource slack remains substantial. Worries are mounting about fiscal deficits and increases in the ratio of debt-to-income that are unprecedented in our peacetime era and constrain the options of fiscal authorities. And if the shift of monetary policy is not too extreme, is limited in duration and accompanied by a clearly defined exit policy, there can be few objections.

But observations of policy-making over the years raise doubts that an ad hoc entry into a new policy regime will be followed by a nimble exit when the appropriate time comes. The fear is that, once the sell-by date of these initiatives passes, central bankers will be acting contrary to everything learnt, painfully, in the 1970s. They will be relating monetary management to real variables on a longer-term basis.

In the end, any short-term benefit will be dwarfed by the long-run pain as they push inflation higher in the vain pursuit of a real economic objective.

While there may now be a case for some further temporary monetary expansion, this can be done within the context of the present flexible inflation target.

Central bankers would be better employed by improving unconventional instruments of monetary policy. The UK’s funding-for-lending scheme is a good start, as it offers a route to stimulating aggregate demand that bypasses the clogged arteries of conventional stimulus. The BoJ already has a significant portfolio of loans on its books, and the Fed would be wise to follow if the pace of the US expansion remains tepid.

Adopting a nominal income (NGDP) target is viewed as innovative only by those unfamiliar with the debate on the design of monetary policy of the past few decades. No one has yet designed a way to make it workable given the lags in the transmission of monetary policy and the publication of national income and product. Rather, a NGDP target would be perceived as a thinly disguised way of aiming for higher inflation. As such, it would unloose the anchor to inflation expectations, which could raise, not lower, interest rates by elevating uncertainty about the central bank’s reaction function.

We do not know, and cannot predict, what will be the sustainable rate of real growth in our economies. Let’s hope it is well above the relative stagnation observed in recent years in the UK, US, and Japan. But it would be over-optimistic to believe our economies can permanently revert to prior faster growth. In the short run, excess monetary expansion might temporarily lead to a burst of growth. But the likely implications of a dash for growth and the abandonment of an inflation target would at some point unhinge the government debt market.

History counsels caution in assessing where that tipping point might be. While interest rates can be forcibly held down for a time by ever-more-aggressive purchases of government debt and vocal commitments to negative real policy rates, the expression of private self-interest cannot be held at bay forever. Should the view take hold that the authorities had given up on inflation in the pursuit of real variables, the extent of monetisation would be of a different magnitude from anything seen so far. It would also put central bankers at the razor’s edge of high inflation on one side and renewed depression on the other. Possible, perhaps, but not a comfortable place to be.

Charles Goodhart is a senior UK economic adviser for Morgan Stanley. Vincent Reinhart, chief US economist at Morgan Stanley, contributed to this article.

Copyright The Financial Times Limited 2013.

January 29, 2013 7:07 pm
A perilous journey to full recovery
Key to success everywhere will be timing the exit from exceptional policies
Ingram Pinn illustration©Ingram Pinn

“We have avoided collapse, but we need to guard against any relapse. 2013 will be a make-or-break year.” These were the words of Christine Lagarde, managing director of the International Monetary Fund, at the World Economic Forum last week. She was right. The business people, policymakers and pundits in Davos breathed a sigh of relief. For the first time since 2007, the focus of the discussion was not upon financial calamity. Yet the fact that the economies of the high-income countries have not fallen off their rickety bridge does not guarantee a swift return to growth. That may well come. But it is not yet ensured.

Confidence has improved. One indicator is the spread between the London interbank offered rate (Libor) and the overnight indexed swap rate (OIS), which offers a measure of the risk of default in the lending of banks to one another. These spreads have fallen to just 10 basis points in euros and 16 in US dollars. Stock markets have also recovered strongly from troughs in March 2009, particularly in the US.

Spreads between the yields on sovereign bonds of vulnerable eurozone sovereigns and those on German Bunds have fallen substantially: in Italy, the spread fell from 5.3 percentage points in late July 2012 to 2.6 percentage points on January 25 2013; in Spain, it fell from 6.4 to 3.4 percentage points. As confidence in sovereigns has improved, so has that in banks. (See charts.)

Real stock markets

Improvement in confidence is not limited to high-income countries. In its January Global Economic Prospects, the World Bank notes that “international capital flows to developing countries ... have reached new highs”; that “developing country bond spreads ... have declined by 127 basis points since June [2012]”; and that “developing country stock markets have increased by 12.6 per cent since June”. This then is a global change.

What explains the rising optimism? One reason is that feared disasters – a break-up of the eurozone or a fall over the US fiscal cliff – have been avoided. 

Another is that substantial post-crisis adjustment has occurred, above all in the US, where private leverage and house prices have gone through a significant rebalancing: US private debt is back to 2003 levels relative to gross domestic product, for example. Yet another explanation is rising trust in the competence of policy makers.

Above all, central bankers have used ultra-expansionary monetary policies to pull the economies for which they are responsible for a long time. The US Federal Reserve’s federal funds rate has been 0.25 per cent for more than four years, with more to come.

Even the European Central Bank, the most cautious of the big central banks, has adopted what would have seemed an irresponsibly easy policy in any previous era, with interest rates at 0.75 per cent since last July.

Even so, the future seems far from golden. In an update of its forecasts for the World Economic Outlook, the International Monetary Fund has painted a far from rosy picture: growth of 2 per cent in the US, 1.2 per cent in Japan, 1.0 per cent in UK and -0.2 per cent in the eurozone this year, though the emerging and developing countries are forecast to be far stronger, with growth of 5.5 per cent. The two-speed world economy remains in place.

In time, rising confidence should drive growth, but only if it is sustained. The question is whether it will be. On this there are reasons for both pessimism and optimism.

The big reason for pessimism is that high-income countries remain stuck in a contained depression. The extended period of ultra-loose monetary policy, including both exceptionally low interest rates and huge expansions in the balance sheets of central banks, is one indicator of this. Another is the size of fiscal deficits in a number of high-income countries. Yet another is the weakness of economies, despite the scale of the policy support.

Of the six largest high-income countries, only the US and Germany had higher output in the third quarter of last year than at their pre-crisis peaks and, even then, the rise was small, at 2.5 per cent in the US and 2 per cent in Germany. Output in France, Japan, the UK and Italy was below its pre-crisis peak. Output in France and the UK is stagnant, in Japan erratic and in Italy plunging. This is truly a miserable picture.

In the eurozone, the ECB succeeded in removing the tail risk of a eurozone break-up by gaining German support for a promise to buy sovereign bonds. It was victorious without firing a shot.

But that does not tell us what would happen if it had to start firing. The ECB might still be forced to deliver on its promises to buy. Nobody knows what would happen, particularly if countries were not expected to stick to the conditions for support.

It is also possible to envisage big problems arising from managing fiscal and monetary policy. The dangers are of tightening too soon or of tightening too late: too soon and the recovery may be aborted; too late and inflationary expectations may become embedded, once again.

Some argue that an inflation upsurge is already around the corner. Now that Japan has joined the party with its “Abenomics, that seems a bigger risk than before. Yet I doubt that these hitherto false prophets will be proved right – I fear premature tightening far more. But the uncertainty is great. The ability of policy makers to manage these risks successfully is doubtful, as Gavyn Davies noted in a comment on the contribution of Mark Carney, next governor of the Bank of England, to a panel in Davos.

But there are also reasons to be optimistic about the future. Emerging economies have shown sustained dynamism, even if there have been disappointments. With the rebalancing that has occurred, as well as an energy revolution, the US might surprise on the upside. Japan might escape deflationary doldrums. Finally, the return of private capital to the eurozone periphery might initiate a virtuous upward spiral of confidence and spending. A key to success everywhere will be timing the exit from exceptional policies.

Policy makers responded successfully. In the case of the eurozone, they were almost too late. But, in the end, the ECB promised action. That promise has proved stunningly effective, so far. A chance of a return to sustained growth is now emerging, though least of all in Europe.

Substantial fiscal and monetary support is still essential. If policy makers sustain the effort, the world could be far closer to full recovery a year hence.

Copyright The Financial Times Limited 2013.

January 29, 2013
It’s P.Q. and C.Q. as Much as I.Q.

President Obama’s first term was absorbed by dealing with the Great Recession. I hope that in his second term he’ll be able to devote more attention to the Great Inflection.

Dealing with the Great Recession was largely aboutYes We Can” — about government, about what we can and must dotogether” to shore up the safety nets and institutions that undergird our society and economy. Obama’s Inaugural Address was a full-throated defense of that “publicside of the unique public-private partnership that makes America great. But, if we’re to sustain the kind of public institutions and safety nets that we’re used to, it will require a lot more growth by the private side (not just more taxes), a lot more entrepreneurship, a lot more start-ups and a lot more individual risk-takingthings the president rarely speaks about. And it will all have to happen in the context of the Great Inflection.

What do I mean by the Great Inflection? I mean something very big happened in the last decade.

The world went from connected to hyperconnected in a way that is impacting every job, industry and school, but was largely disguised by post-9/11 and the Great Recession. In 2004, I wrote a book, called “The World Is Flat,” about how the world was getting digitally connected so more people could compete, connect and collaborate from anywhere. When I wrote that book, Facebook, Twitter, cloud computing, LinkedIn, 4G wireless, ultra-high-speed bandwidth, big data, Skype, system-on-a-chip (SOC) circuits, iPhones, iPods, iPads and cellphone apps didn’t exist, or were in their infancy.

Today, not only do all these things exist, but, in combination, they’ve taken us from connected to hyperconnected. Now, notes Craig Mundie, one of Microsoft’s top technologists, not just elites, but virtually everyone everywhere has, or will have soon, access to a hand-held computer/cellphone, which can be activated by voice or touch, connected via the cloud to infinite applications and storage, so they can work, invent, entertain, collaborate and learn for less money than ever before.

Alas, though, every boss now also has cheaper, easier, faster access to more above-average software, automation, robotics, cheap labor and cheap genius than ever before. That means the old average is over. Everyone who wants a job now must demonstrate how they can add value better than the new alternatives.

When the world gets this hyperconnected, adds Mundie, the speed with which every job and industry changes also goes into hypermode. “In the old days,” he said, “it was assumed that your educational foundation would last your whole lifetime. That is no longer true.” Because of the way every industry — from health care to manufacturing to education — is now being transformed by cheap, fast, connected computing power, the skill required for every decent job is rising as is the necessity of lifelong learning.

More and more things you know and tools you use “are being made obsolete faster,” added Mundie. It’s as if every aspect of our lives is now being driven by Moore’s Law. This is exacerbating our unemployment problem.

In their terrific book, “Race Against the Machine: How the Digital Revolution Is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy,” Erik Brynjolfsson and Andrew McAfee of the Massachusetts Institute of Technology note that for the last two centuries it happened that productivity, median income and employment all tracked each other nicely. “So most economists have had this feeling that if you just boost productivity, the pie grows, and, in the long run, everything else takes care of itself,” explained Brynjolfsson in an interview. “But there is no economic law that says technological progress has to benefit everyone. It’s entirely possible for the pie to get bigger and some people to get a smaller slice.” Indeed, when the digital revolution gets so cheap, fast, connected and ubiquitous you see this in three ways, Brynjolfsson added: those with more education start to earn much more than those without it, those with the capital to buy and operate machines earn much more than those who can just offer their labor, and those with superstar skills, who can reach global markets, earn much more than those with just slightly less talent.

Put it all together, he added, and you can understand, why the Great Recession took the biggest bite out of employment but is not the only thing affecting job loss today: why we have record productivity, wealth and innovation, yet median incomes are falling, inequality is rising and high unemployment remains persistent.

How to adapt? It will require more individual initiative. We know that it will be vital to have more of the “righteducation than less, that you will need to develop skills that are complementary to technology rather than ones that can be easily replaced by it and that we need everyone to be innovating new products and services to employ the people who are being liberated from routine work by automation and software. The winners won’t just be those with more I.Q. It will also be those with more P.Q. (passion quotient) and C.Q. (curiosity quotient) to leverage all the new digital tools to not just find a job, but to invent one or reinvent one, and to not just learn but to relearn for a lifetime. Government can and must help, but the president needs to explain that this won’t just be an era of “Yes We Can.” It will also be an era of “Yes You Can” and “Yes You Must.”