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Friday, February 19, 2016

The Return Of The High Pressure Economy

The potential for rapid economic growth in the United States has popped up again as a partisan political issue. J.W. Mason has written an excellent article -- "Can Sanders Do It?" -- discussing the hubbub that has arisen around rapid growth projections based on Democratic candidate Sanders' economic plans. (On the Republican side, there previously was a debate regarding the growth projections given by the candidate Jeb Bush.) I agree whole-heartedly with J.W. Mason -- a return to a period of rapid growth in the United States is certainly possible. However, for those of my readers are obsessed about the government bond market, that should raise the hairs on the back of your neck...

I will first underline that I am not endorsing, or even glancing at the economic plans of any presidential candidate.* I will only worry about economic plans of after the elections. Given the political paralysis in the United States, it remains to be seen whether any plans really will make a difference.

Is Rapid Growth Possible?

J.W. Mason has an excellent summary of how he looks at this issue:
I want to try to clarify the stakes in this debate. There are three questions, each logically prior to the other.
1. Is it reasonable to think that better macroeconomic policy could deliver substantially higher output and employment?
2. Are the kinds of things proposed by Sanders capable in principle of getting us there?
3. Are the specific numbers in Sanders’ proposals the right ones for such a really-full employment plan?
The second question doesn’t matter until we’ve answered yes to the first one. And the third doesn’t matter until we’ve answered yes to the first two.
The first question is not only logically prior, it also seems to be what the public debate is actually about . 
As he suggests, the most important question is the first one; the second and third ones really only matter with regards to American partisan politics.

Regular readers will have noticed that I have a "the glass is half empty" view on economic growth, and I spent my career in finance as a secular bond bull. (One may note that I have the category "Slow Growth" on my web site, but no "Rapid Growth" or "Overheating" categories.) That said, with the 10-year Treasury trading below 2%, there's not a whole lot of room left in that secular bull market. Instead, a rates forecaster needs to think long and hard about what will cause interest rates to rise in a sustained fashion. A good clip of rapid economic growth is exactly what would cause that interest rate rise, and so that possibility has to be taken seriously.

Yes, It Can Be Done

 A fairly long period (5-8 years, say) of rapid growth in the United States is certainly possible. (This used to be called a "high pressure economy".) There is no doubt that it is possible to induce high nominal GDP growth; what matters is growth adjusted for inflation (real GDP growth). Although I do not see a requirement that inflation must be low in order to have strong real GDP growth, inflation would still need to be managed.

Since it is unlikely that there will be rapid population growth, faster real GDP growth implies faster per capita real GDP growth (that is, productivity growth). Economists tend to wring their hands about productivity growth, but I see little reason that it has to be low over the time interval we are discussing here.
  • As discussed in the J.W. Mason article, there is plenty of slack in the labour market. The participation rate can rise a lot. Job creation will pull people out of dead-end academic courses, and employers will be forced to once again train people on the job.
  • Rising wages need not be inflationary, as the profit share of GDP could decline. That is, profits may be increasing, but at a slower pace than GDP growth. (This was also discussed by J.W. Mason.) As a result, although we would expect wages to rise, this effect would cushion the effect on consumer prices.
  • The only difference between 2% growth and 3% growth is a change in definition of the GDP deflator. Changes in the economic mix may allow for greater nominal GDP growth without affecting the GDP deflator (which means that real GDP growth would be higher). In other words, GDP growth is only loosely related to the notion of "output capacity."
  • The U.S. can draw on excess capacity in exporting nations. That excess capacity will help cap price rises in the United States. (Obviously, not every nation could simultaneously rely upon this mechanism.)
  • GDP growth is ultimately defined by dollar value, not real resources. It is possible to have rapid GDP growth without hitting real resource (e.g., oil) constraints.
  • There are a lot of dead-end employers in the economy, in sectors that are massively over-capacity (restaurants, retail). That capacity can be culled, leaving the survivors running much more productive businesses.
  • Similarly, there are a lot of white collar jobs that have very little relationship to producing goods and services that are actually needed. Those industries can also have their capacity culled, freeing up highly educated workers, and raising the productivity of those remaining.
  • The inflation process is a lot stickier than people give it credit for. There is no particular reason to believe that a 2% unemployment rate would cause much higher inflation than a 4% unemployment rate. In my view, the only way to kindle much higher inflation would be for widespread indexation in contracts.
As for the mechanism, anything that creates a surge of fixed investment will tend to create a self-reinforcing upward spiral in private sector activity. All that needs to be ensured is that the financing mechanism for that investment to not be fragile (as was the case for the telecom and housing booms).


* Although I do have a bias against candidates that are calling for a wall along the Canadian border.

(c) Brian Romanchuk 2015


  1. "That said, with the 10-year Treasury trading below 2%, there's not a whole lot of room left in that secular bull market."

    Really? Debt deflation and negative yields aren't something that keep you up at night? I disagree with your comment, you're trying to play devil's advocate but you're ignoring the global deflation tsunami coming our way. And for a bond guy who called out JGB bears over the last two decades, I'm surprised you don't see the possibility of a long period of ultra low/ negative rates.

    1. There is no doubt that we could be stuck in a long period of low interest rates. You will make money slowly from carry and roll down, which is what has been happening in Japan for almost 20 years, but that's not much of a bull market. The really exciting moves, if and when they occur, will almost by definition have to be sell offs.

      I have serious doubts about negative interest rates. The Fed is already unpopular with both wings of the political spectrum; I doubt that they want seniors burning them in effigy every time they lose money on their fixed income investments...


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