Noah Millman -- blogger for The American Conservative
A variety of much more knowledgeable commentators than I have been making the case for some time that the primary cause of our lingering economic difficulties is that the Fed has been too tight with money. Scott Sumner is probably the best exponent of this view, and of the view that a change in the Fed's policy framework is necessary to address this problem effectively for both the short and long term (if the Fed targeted NGDP rather than following some version of the Taylor rule, he argues, the policy responses during both the Great Recession and the Great Inflation of the 1970s would have been more correct), and he's won support from both the left and the right for his views - which makes sense because, from the left's perspective, he's making an argument for higher inflation and for placing a higher priority on reducing unemployment versus protecting the interests of asset-holders, while from the right's perspective he's articulating a policy alternative that could actually address our economic problems without increasing spending or the scope of involvement of the Federal Government in the economy (as a Keynesian fiscal policy would be likely to do).
If we don't -- if there's been a drop in the long-term growth potential of the American economy -- then an inflationary response will at best mask that fact. Assuming we can successfully target a 5% NDGP growth rate, there is a big difference between a situation where the inflation component of that rate is stable, whether it's stable at between 1.5% and 2.5%, and a situation where the inflation component of that rate is 3.5% and rising, and the real growth rate is 1.5% and falling, because while nominal growth is the right measure of economic activity, real growth is the right measure of wealth-generation.
Why, though, would such a drop have occurred? Did everybody's left arm fall off with the financial crisis? No, of course not. But there are a variety of possible explanations for why the long-term growth potential of the economy has deteriorated over time. The skill level of our workforce is stagnating, possibly because of poor productivity in the education sector, possibly because of demographic change, likely because of both. The tax system has grown markedly less-efficient since the last round of tax reform. The drivers of the financialization of the economy are hard to discern, but the effects aren't. The inefficiencies of our enormous health-care sector are well-known; that's 16% of the economy, and growing. The atrocious inefficiencies of infrastructure investment in America are less-well-known, but quite serious - we get less bang per buck than basically any other developed country, and as a consequence we have almost stopped investing in our physical infrastructure. Rent-seeking in the patent system, anybody? An over-extended military sector?
It's not actually hard to come up with a list - a list that withstands some scrutiny based on international and historical comparisons. None of the trends on this list appeared overnight, of course. The argument, then, is that these factors eroded the long-term growth potential for the economy, but that the market didn't respond to these facts because abnormally fast credit growth masked them, making it look like the growth potential of the economy was as strong as it had been. Which then raises the question: why was credit growth abnormally fast during the bubble period?
It seems to me that the monetary explanation of the aftermath of the crisis needs to be extended backward to account for the bubble that preceded the crisis. Was monetary policy too loose in the 2003-2007 period? If so, and this fueled the bubble, then unemployment was (effectively) too low and nominal growth too high during this period as well. Which, in turn, seems to me to bolster the position of those who argue for an underlying structural explanation of our problems. If the anemic growth of the Bush years was actually higher than it "should have been" with proper monetary policy, then that fact requires an other-than-monetary explanation.