Sunday, December 8, 2013

Paul Krugman Argues That Secular Stagnation Seems Probable Without Help From Monetary Policy And Trade Policy

Krugman chops his way through some some numbers and comes to the conclusion that the positive factors that supported the Great Moderation have disappeared.  Household debt was growing at a 2% rate during the GM and that will not continue; the CBO forecasts that potential GDP will be 1% less than during GM as well. These declining demand factors will cause fixed investment to decline by 2% of GDP.  Real interest rates were 1.9% during the GM and they will have to be negative to offset the factors that limit growth in demand. We will continue to be in a liquidity trap.   The good news is that the US current account deficit averaged around 3% during the GM.  If we could eliminate the trade deficit we could avoid stagnation.  He argues that low interest rates and a higher inflation rate should cause the dollar to weaken and that should eliminate the trade deficit.

Krugman's recipe for escape from stagnation will be difficult to achieve in a post industrial society.  We have a trade surplus in services but services are small percentage of international trade.  The majority of tradable goods are industrial products.  Moreover, around 50% of our imports are by US firms which resell them in the US.  They have lots of reasons for offshoring production that would not be strongly affected by a weaker dollar.

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