It is true that even some forecasters who have had the wisdom to remain pessimistic about growth prospects for the last few years are coming around to more optimistic views about growth in 2014, at least in the US. This is encouraging, but optimism should be qualified by the recognition that even optimistic forecasts show output and employment remaining well below previous trends for many years. More troubling, even with the current high degree of slack in the economy and wage and price inflation slowing, there are increasing signs of eroding credit standards and inflated asset values. If we were to enjoy several years of healthy growth with anything like current credit conditions, there is every reason to expect a return to the kind of problems we saw in 2005-2007 long before output and employment returned to trend or inflation accelerated.
The secular stagnation challenge then is not just to achieve reasonable growth, but to do so in a financially sustainable way. What then is to be done Essentially three approaches compete for policymakers attention. The first emphasises what is seen as the economys deep supply side fundamentalsthe skills of the workforce, companies capacity for innovation, structural tax reform, and assuring the long-run sustainability of entitlement programmes. All of this is intuitively appealing, if politically difficult, and would indeed make a great contribution to the economys health over the long run. But it is very unlikely to do much over the next 5 to 10 years. Apart from obvious lags like those with which education operates, there is the reality that our economy is constrained by lack of demand rather than lack of supply. Increasing our capacity to produce will not translate into increased output unless there is more demand for goods and services. Training programmes or reform of social insurance, for instance, may affect which workers get jobs, but they will not affect how many get jobs. Indeed, measures that raised supply could have the perverse effect of magnifying deflationary pressures.
The second strategy that has dominated US policy in the recent years has been lowering relevant interest rates and capital costs as much as possible and relying on regulatory policies to assure financial stability. No doubt the economy is far stronger and healthier now than it would be in the absence of these measures. But a growth strategy that relies on interest rates significantly below growth rates for long periods of time is one that virtually insures the emergence of substantial financial bubbles and dangerous build-ups in leverage. It is a chimera to hold out the hope that regulation can allow the growth benefits of easy credit to come without the costs. Increases in asset values and increased ability to borrow stimulate the economy and are precisely the proper concern of prudential regulation.
The third approachand the one that holds the most promiseis a sustained commitment of policy to raising the level of demand at any given level of interest rates through policies that restore a situation where reasonable growth and reasonable interest rates can coincide. To start, this means ending the disastrous trends towards less and less government spending and employment each year, and taking advantage of the current period of economic slack to renew and build out our infrastructure. In all likelihood, if the government had invested more over the last 5 years, our debt burden relative to income would be lower today given the way in which economic slack has hurt the economys long-run potential, so it would not have imposed any burden on future taxpayers.
Raising demand also means seeking to spur private spending. There is much that can be done in the energy sector to unleash private investment on both the fossil fuel and renewable sides. Regulation that requires the more rapid replacement of coal-fired power plants will increase investment and spur growth as well as help the environment. And it is essential to insure in a troubled global economy that a widening trade deficit does not excessively divert demand from the US economy.
Secular stagnation is not an inevitability. With the right policy choices, we can have both reasonable growth and financial stability. But without a clear diagnosis of our problem and a commitment to structural increases in demand, we will be condemned to oscillating between inadequate growth and unsustainable finance. We can do better.