Investment and the Recovery

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Over the past few days, I have been following a debate between Barro, Krugman, Mankiw and Chin about investment and the economic (non)recovery.

All the players are basically as you would expect. Barro thinks that stimulus does not work, and that austerity is the solution. Krugman is nasty to Barro, off cuff, and thinks it is all about demand – but is basically at cross purposes with Barro. Mankiw is moderate; and Chin presents facts and is typically soft-left.

It is worth reading Chin, who shows that firms have fairly robust demand for new capital, relative to the prior recession-recovery. The real problem is that their demand is not sufficient given the real and financial resources available to them.

My assessment is that uncertainty – both regulatory and otherwise – is having a big dampening impact on both the real economy and financial markets. For example, equities are very cheap by most metrics, but cash keeps flowing into fixed income. It piles in as fast as governments can issue, as both household and corporate savings are directed into fixed income, thanks to a strong preference for lower risk government debt.

What is the solution? The world needs long term reform of entitlement and health spend (yes, even Australia) to create a credible medium term fiscal framework within which increased spending is plausible. Once fiscal credibility is established, large scale Government investment in long term infrastructure should be undertaken.

Wasteful spending is not okay, it has to be stuff that has an IRR that is higher than Government borrowing rates – but that should not be hard, particularly in the US and UK, where long term real yields are negative.


  1. What do you think about Scott Sumner’s thesis that the recovery is being held back (and the great recession was caused by) overly tight monetary policy relative to indicators of expected nominal GDP?

    1. I think Sumner is correct that what hurts is that the debts are still around, but the incomes that were expected to support them are not. I am persuaded that this part of his focus on expectations is appropriate. I am not, however, confident that the is all that much that monetary policy can do. I also dislike his NGDP futures idea as I think it is unworkable.

      I am pretty sure Sumner thinks the US needs higher wages, but he takes higher nominal GDP as a proxy. You must be careful what you wish for here. If QE2 did anything, it reduced real consumption wages by speeding up EM and pushing up commodity prices.

      This made debts harder to repay.

  2. I think Sumner might say that the fact QE2 reduced real consumption wages was indicative of, and one of the reasons behind, its success. After all, his blog is not called ‘The Money Illusion’ for nothing. I think Sumner would want to see higher wages in the US, but as the result of NGDP growth and not as a direct result of policy itself.

    1. I think he thinks money policy did do it, can do it, and is overconfident about what monetary policy can achieve in general. Do you really think that easier rates in 2005 would have stopped the US housing bubble from busting? I do not.

      Not all problems are monetary, and not all can be solved by monetary policy. There are also real problems (capital misallocation) at work.

      Finally, QE2 didn’t do anything. It was probably way too small (say ~50bps equivalent). Moreover, the lag means too little time has passed to be able to tell for sure.

      Sent from my iPad

      1. I can hardly speak for Sumner – see his blog today (15 Sept) for a post on the very question of sticky wages and what he thinks this means for monetary policy.

        There is also another post earlier on the same day where he reiterates his view that the US housing subprime bust of 2006-08 did precede the recession, but the recession greatly worsened and broadened the housing bust, which then triggered the financial crisis in late 2008.

        At the end of the same post, he acknowledged that the initial housing bust was due to a misallocation of resources, and he often refers to this. He just thinks the US is in a situation right now where unemployment is higher than it needs or should be due to tight money. He would also agree that QE2 was too small, but that it was better than nothing.

        I will stop defending him now, not my job!

  3. Interest rates are only higher because they would need to be negative quite a bit to be where they should be.

    Makiw a ‘moderate and Chin is ‘soft left’. interesting label. Mankiw is kidding himself when he says demand doesn’t cause investment to grow or contract.

    Anyone such as Barro who continues to advocate austerity when it doesn’t work and we live in a Keynesian world as study after study shows is simply going gaga.

    It is very simple the US needs a decent stimulus package. this time the States will not reducing its impact.

    1. I agree with Krugman on that … This is a liquidity trap. But there are a few moving parts, and increasing expected future profits is just as useful a way of boosting demand as cutting the discount rate. It has the same impact on the incentive to invest, consume etc.

      Sent from my iPad

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