How Should We Explain Slow Growth In The US?

The conventional way to measure economic output, or GDP, is to add up the sources of output.  Consumption is about 70% in the US, and business investment, government spending and net exports make up the rest.  The conventional explanation of recessions, from a demand perspective, is to blame recessions on inadequate business investment.  Therefore, central banks can lower interest rates, which makes it less expensive for businesses to fund investment.  If that doesn't work, the alternative is to increase government spending and run budget deficits.  The concept of secular stagnation has been used by Larry Summers, Paul Krugman and others to explain the slow recovery in the US.  It is based on the concept of the "liquidity trap".  We have a liquidity trap when the central bank has lowered interest rates to zero but we also have low inflation.  In that situation real interest rates will be somewhat below zero but the real interest rates need to be more negative in order to stimulate investment spending.  One way to lower the real interest rate in a liquidity trap is increase the inflation rate.  Central banks, however, have a target rate of 2% inflation, and they have little interest in raising that target.  Therefore, economists like Summers and Krugman argue that fiscal policy is needed to stimulate the economy.  That happens when governments run large budget deficits.  That is not politically possible in the US.  So secular stagnation is the consequence.  We are in for a long period of slow growth and high unemployment.

Dean Baker points to another problem that may be responsible for high unemployment.  Net exports are negative in the US.  That is because we import more than we export. Net exports currently reduce GDP by 3%.  In an economy the size of the US that is a big number.  Moreover, it reduces GDP by an amount that is much larger than any amount that we could expect to gain from an increase in business investment.  Economic theory suggests that trade deficits are self correcting.  The dollar should fall in value relative to the value of the currencies our trading partners with whom we have a trade deficit.  The less expensive dollar will make US exports less expensive and the trade deficit should disappear.  That has not happened.  The US has been running large trade deficits for many years.  Dean Baker believes that we will continue to have high unemployment as long as we run large trade deficits.  It is difficult to overcome this problem without raising questions about globalization and the virtues of free trade.  Consequently, the only alternative is to run large budget deficits to compensate for the trade deficit. We are doing the opposite in the US.