The common wisdom is that excessive debt-financed spending was one of the causes of the recent recession, so the news that household debt is dropping is being celebrated by business cheerleaders as reason to believe we’re on the mend.
Baloney. The reason so many Americans went into such deep debt was because their wages didn’t keep up. The median wage (adjusted for inflation) dropped between 2001 and 2007, the last so-called economic expansion. So the only way typical Americans could keep spending at the rate necessary to keep themselves — and the economy — going was to borrow, especially against the value of their homes. But that borrowing ended when the housing bubble burst.
So now Americans have no choice but to pare back their debt. That’s bad news because consumer spending is 70 percent of the economy. It helps explain why we so few jobs are being created, and why we can’t escape the gravitational pull of the Great Recession without far more government spending.
It’s also a bad omen for the future. The cheerleaders are saying that for too long American consumers lived beyond their means, so the retrenchment in consumer spending is good for the long-term health of the economy. Wrong again. The problem wasn’t that consumers lived beyond their means. It was that their means didn’t keep up with what the growing economy was capable of producing at or near full-employment. A larger and larger share of total income went to people at the top.
So in the longer term, it’s hard to see where the buying power will come from unless America’s vast middle class has more take-home pay. Yet the economy is moving in exactly the opposite direction: Businesses continue to slash payrolls. And the hourly wage of the typical American with a job continues to drop, adjusted for inflation.
and Why we are moving toward a recessionary era, and why Keynes is being exhumed:
... demand always seems on the verge of trailing the nation’s productive capacity. The biggest ongoing threats are chronic recession or even deflation, because consumers don’t have enough money to what the economy is capable of selling at full or near-full employment. Despite gains in productivity, little has trickled down to America’s middle class. John Maynard Keynes is being exhumed because his Depression-era worry about inadequate demand is once again the nation’s central economic problem.
Paul Krugman discusses some economists' Strange arguments for higher rates.
My take on the current economic situation is quite simple, and I would have thought corresponds to standard economics. Right now, we clearly don’t have enough demand to make full use of the economy’s productive capacity. This means that the real interest rate is too high. And so the “natural” thing is for the real rate to fall. Yes, that would mean a negative real rate....
Surely... we want to get rates as close to their appropriate level as possible — which means a zero nominal rate. There’s nothing “unnatural” about it. On the contrary, the “natural rate of interest”, as Wicksell defined it, is clearly negative right now.
Andy Harless itemizes 7 reasons to be concerned about double-dip, and 6 (less compelling) items that make the case against a double dip, in Second Dip? and then concludes:
What worries me particularly is that, even if the case for a second dip is completely wrong, the employment picture going forward is still dismal, and there is still a case for deflation.
Am I wrong in understanding that this is standard textbook macroeconomics? There is a non-accelerating inflation rate of unemployment (NAIRU). When the actual unemployment rate is above the NAIRU, the inflation rate declines. The further the unemployment rate is above the NAIRU, the more quickly the inflation rate declines. The unemployment rate is currently 9.7% and is not expected to fall rapidly, even under optimistic scenarios. Recent estimates put the NAIRU at about 5%. The current core CPI inflation rate is about 1%. You do the math.
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