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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