What if slow economic growth is the new normal?
With U.S. economic growth stuck in low gear for several years, it’s leading many economists to worry that the country has entered a prolonged period where any expansion will be weaker than it has been in the past. Are these worries justified? And if so, what might the consequences be for the future of America’s economy?
Let’s look at some explanations for today’s subpar growth rates and what it might mean if they’re not reversed:
One theory about why economic growth has slowed, proposed by Robert Gordon, is that the country has entered an era where productivity growth will be much lower than in the past. According to Gordon, the digital revolution now underway is much less important than inventions that came about between 1870 and 1970 such as electricity, sanitation, chemicals, pharmaceuticals, transportation systems (the internal combustion engine in particular) and communication.
Therefore, we shouldn’t expect the same boost to productivity from digital technology. Because rising productivity is the key to rising living standards, lower productivity growth will reduce the rate that living standards improve.
A second explanation that has been offered to account for the recent period of low economic growth is known as secular stagnation. According to this theory, first proposed by Alvin Hansen in the 1930s and recently revived by Larry Summers, sluggish economic growth can be traced to an imbalance between saving and investment.
As Summers has noted: “The economies of the industrial world, in this view, suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. The result is that excessive saving acts as a drag on demand, reducing growth and inflation, and the imbalance between savings and investment pulls down real interest rates.”
If today’s low growth persists into the future due to either lower productivity growth or an extended period of secular stagnation, these are the likely consequences:
First, people who save or lend money will realize lower returns. Retirement savings, for example, will not grow as fast. However, while low interest rates hurt savers and lenders, people who borrow money to purchase, say, a house or a car will be better off because they’ll have lower monthly payments.
Second, lower interest rates reduce the Fed’s ability to fight severe recessions. If average interest rates are 2 percent, then the Fed can cut rates by only 2 percent before running into the “zero lower bound.” When interest rates hit the zero bound, the Fed loses its most powerful tool for stimulating the economy. But if average interest rates were 4 percent, the Fed would have twice as much room to cut rates before they hit zero.
Third, a prolonged period of low growth, particularly if secular stagnation is the cause, will lead to low inflation. Lower inflation helps people who receive fixed monthly payments (e.g., a pension income with no adjustment for inflation or a payment from a borrower with a fixed-rate loan) and hurts people making the payments (the company paying the pension or the borrower).
For example, a person taking out a fixed-rate mortgage with the same monthly payments over the next 30 years will be worse off if the average rate of inflation turns out to be lower than expected when the loan was made.
Fourth, lower economic growth also makes it harder to address income inequality for two reasons. First, wages grow fastest when the economy is at full employment, and more rapid wage growth helps workers grab a larger share of the economic pie. Second, when economic growth is robust and income is growing relatively fast, people are more likely to support tax and social insurance policies that redistribute income.
Fifth, slower economic growth reduces tax revenues and because employment also grows slower, finding a job becomes more difficult, which also increases government spending on social programs. The result is a larger budget deficit than there would be with higher economic growth. Larger deficits lead to pressure either to raise taxes (which will be opposed on the basis that it could hurt growth even more) or to cut spending on social insurance programs such as Social Security, Medicare and Obamacare.
Sixth, when interest rates are low, the risk of creating financial bubbles increases, as investors’ “search for yield” causes them to take excessive risks. As Summers has argued, during periods of secular stagnation, “When significant growth is achieved … as in the United States between 2003 and 2007 -- it comes from dangerous levels of borrowing that translate excess savings into unsustainable levels of investment (which in this case emerged as a housing bubble).”
Finally, if the U.S. does enter a long period of slow growth, people will hold whoever is president at the time responsible. If voters are less supportive, it will be more difficult for the president to implement his or her agenda. Whether that’s good or bad depends upon who wins the election, and which side of the political fence you’re on.
