Wednesday, October 14, 2015

Still stuck in slow-growth mode

Not much to cheer about these days. The economy is still underperforming, with a lot of unused (human) capacity. But at least it is still growing—and simply avoiding a recession is a great thing, since it means that risky investments with attractive yields are likely to beat cash.

September retail sales were disappointing, but mainly because of falling energy prices. Strip out autos and gas stations and you find that sales rose 3.75% in the past year, exactly the same as their annualized growth over the past four years. The chart above shows that, as well as the potential magnitude of the general shortfall in growth (arguably as much as 15%) in the current business cycle expansion. We could be doing a lot better, to be sure, but continued growth is much better than another recession.

The August Producer Price Index suffered from the same energy-related impact. The overall index is down 4.1% in the past year, but after stripping out food and energy prices, we find that inflation at the wholesale level is running about 2%, very much in line with what we've seen for the past several years.

We're still living in a slow-growth, 2% inflation world.

That's actually remarkable, because sluggish growth and plenty of excess capacity should have resulted in years of very low or negative inflation, according to the popular but flawed Phillips Curve theory of inflation. Contrary to what many have feared, years of slow growth have not led to even slower growth or deflation. The analogy that says the economy is like an airplane approaching stall speed is not apt; neither is it instructive to worry that the U.S. may be following in the footsteps of the notoriously slow-growing Japanese economy. It takes a lot of effort (e.g., very tight monetary policy, as evidenced by high real interest rates, a flat or inverted yield curve, and soaring credit spreads, particularly swap spreads) to generate a recession in the dynamic U.S. economy.

Rather than worry that the economy is at risk of "slipping into recession and/or deflation," we should instead be talking about what needs to be done to allow the economy to grow faster. As I and most other supply-siders see it, the government basically needs to get out of the way and let the private sector do its customary magic. That boils down to cutting marginal tax rates (especially corporate tax rates!), simplifying the tax code, reducing regulatory burdens, and eliminating crony capitalism (e.g., the ex-im bank), among others. In essence, we need a Washington culture that trusts the market to fix things, instead of bureaucrats and agencies.


Rob said...

Scott what do you think of this article, which takes creaking rail infrastructure as a metaphor for US underinvestment ? Thanks.

Lawyer in NJ said...

With interest rates so low and an obvious broad-based need, a bipartisan consensus for massive infrastructure spending should have already produced legislation.

Scott Grannis said...

Re: infrastructure spending as the best way to stimulate the economy. Sorry, I'm too much of a supply-sider to buy into the notion that government spending on infrastructure is a good way to stimulate the economy. Growth doesn't come from spending, it comes from risk-taking, hard work, and ingenuity.

If businesses had great investment opportunities but couldn't pull the trigger because of a lack of roads or a lack of fiber optic cables or a shortage of port capacity, then I might agree. But even then, businesses should be the ones who tell us what needs fixing, replacing, or modernizing. Not someone taking a ride on the train from Boston to JFK.

In any event, didn't we try the massive infrastructure spending idea back in 2009? It didn't work because it turned out there were very few "shovel-ready" projects. The vast majority of the $800+ billion spent went to things that had nothing to do with infrastructure.

Low interest rates aren't a sign of capital just sitting around waiting for demand to pick up. They are a sign that the owners of capital don't see opportunities out there that justify the risks, on an after-tax basis. Low interest rates and weak investment are signs of risk aversion, not an abundance of supply.

Why not reduce the corporate tax rate to zero? It would only "cost" about $300 billion a year, but I'd be willing to bet that we'd see a huge increase in investment and employment, and the knock-off effects of that would generate plenty of revenues, maybe enough to almost cover the "cost" of foregone revenues. Eliminating the corporate tax rate requires only a simple piece of legislation. No politicians need to decide how or where to spend the money. No opportunities for graft or crony capitalism. It puts the decision of how to spend the money directly in the hands of the people most able to decide what makes sense: the owners of capital.

How about reducing top marginal tax rates? My own rate is 65%, and I am absolutely positive that it keeps me on the sidelines. How about reducing or eliminating the capital gains tax? I've got some huge gains that are locked up by the captains tax. If selling and redeploying the money were tax free, I might be willing to fund lots of new investment ideas. But for now I'm loathe to give the government 25-30% of my hard-earned profits.

How about reducing all the red tape that makes it so difficult for new business start-ups, or for some of those infrastructure projects that end up taking decades to clear the environmental impact hurdles?

The last thing we should do is give Washington another blank check with which to embark on an infrastructure spending spree.

Benjamin Cole said...

I like total elimination of corporate income tax. Offset by $300 billion cut in federal agency outlays (mostly "national security").

FICA tax cuts would put money in the hands of those who spend or hire, and those are my favorite tax cuts.

Hard to tell if monetary policy is tight or not. Interest rates strike me as artificially high, and probably should be in the negative range right now. That may be impossible, as savers just move to cash. Ergo, QE is probably necessary.

Japan may in fact be instructive.

M Miller said...

It's all about demographics, slowing labor force growth, etc... all the money printing in the world and stimulus won't change the fact that long-term GDP growth is going down due to structural, deflationary forces. No one seems to want to accept that answer. Read Richard Hokenson, of ISI Economics. He's predicted this consistently and accurately since Fall 2009, to the T.

Mark P. said...


Just wanted to say thank you for sharing your experience, research, and economic insight. I have been following your blog for the past couple years and find it to be one of the most pragmatic, sensible, spot-on, and informative economic resources in my portfolio of on-line resources. Thanks again... -Mark, Portland Oregon.

Scott Grannis said...

Mark: Thank you!