BERKELEY – US Federal Reserve Board Chairman Ben Bernanke is not regarded as an oracle in the way that his predecessor, Alan Greenspan, was before the financial crisis. But financial markets were glued to the speech he gave in Jackson Hole, Wyoming on August 26. What they heard was a bit of a muddle.
First of all, Bernanke did not propose any further easing of monetary policy to support the stalled recovery – or, rather, the non-recovery. Second, he assured his listeners that “we expect a moderate recovery to continue and indeed to strengthen.” This is because “[h]ouseholds also have made some progress in repairing their balance sheets – saving more, borrowing less, and reducing their burdens of interest payments and debt.” Moreover, falling commodity prices will also “help increase household purchasing power.”
Finally, Bernanke claimed that “the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years.”
Frankly, I do not understand how Bernanke can say any of these things right now. If he and the rest of the Federal Open Market Committee thought that the projected growth of nominal spending in the US was on an appropriate recovery path two months ago, they cannot believe that today. Two months of bad economic news, coupled with asset markets’ severe revaluations of the future – which also cause slower future growth, as falling asset prices lead firms to scale back investment – mean that a policy that was appropriate just 60 days ago is much too austere today.
But let me focus on Bernanke’s fourth statement. Even if we project a relatively rapid economic recovery, by the time this lesser depression is over, the US will have experienced an investment shortfall of at least $4 trillion. Until that investment shortfall is made up, the missing capital will serve to depress the level of real GDP in the US by two full percentage points. America’s growth trajectory will be 2% below what it would have been had the financial crisis been successfully finessed and the lesser depression avoided.
There is more: state and local budget-cutting has slowed America’s pace of investment in human capital and infrastructure, adding a third percentage point to the downward shift in the country’s long-term growth trajectory.
After the Great Depression of the 1930’s, the vast wave of investment in industrial capacity during World War II made up the shortfall of the lost decade. As a result, the Depression did not cast a shadow on future growth – or, rather, the shadow was overwhelmed by the blinding floodlights of five years of mobilization for total war against Nazi Germany and Imperial Japan.
There is no analogous set of floodlights being deployed to erase the shadow that is currently being cast by the lesser depression. On the contrary, the shadow is lengthening with each passing day, owing to the absence of effective policies to get the flow of economy-wide nominal spending back on its previous track.
Moreover, there is an additional source of drag. A powerful factor that diminished perceived risk and encouraged investment and enterprise in the post-WWII era was the so-called “Roosevelt put.” Industrial-country governments all around the world now took fighting depression to be their first and highest economic priority, so that savers and businesses had no reason to worry that the hard times that followed 1873, 1884, or 1929 would return.
That is no longer true. The world in the future will be a riskier place than we thought it was – not because government will no longer offer guarantees that it should never have offered in the first place, but rather because the real risk that one’s customers might vanish in a prolonged depression is back.
I do not know by how much this extra risk will impede the growth of the US and global economies. A back-of-the-envelope estimate suggests that a five-year lesser depression every 50 years that pushes the economy an extra 10% below its potential would reduce average investment returns and retard private investment by enough to shave two-tenths of a percentage point from economic growth every year. As a result, America would not just end this episode 3% poorer than it might have been; the gap would grow – to 7% by 2035 and 11% by 2055.
This is the shape of things to come if steps are not taken now to recover rapidly from this lesser depression, and then to implement policies to boost private capital, infrastructure, and education investment back up to trend. Perhaps that would be enough to reassure everyone that policymakers’ current acquiescence in a prolonged slump was a horrible mistake that will not be repeated.