Has the mainstream Democratic Party become too pessimistic about the possibility of boosting economic growth?
That's the more interesting question sparked by economist Gerald Friedman's analysis suggesting that Bernie Sanders's economic agenda, if fully enacted, would lead to 5.3 percent annual GDP growth, soaring household incomes, and an array of other wondrous effects.
The Sanders campaign did not produce the analysis or officially endorse it — indeed, the Sanders campaign never even framed its proposals as an agenda to boost the growth rate — but the campaign did promote it. A bevy of Democratic economists who served as Council of Economic Advisers chairs under either Bill Clinton or Barack Obama pushed back, saying the document is a betrayal of "our party’s best traditions of evidence-based policy making and undermines our reputation as the party of responsible arithmetic."
But a dissident faction of wonks, including J.W. Mason from John Jay College and Matthew Klein of the Financial Times, spoke up for Friedman, saying that essentially all he was arguing was that the economy could get back on its pre-recession growth trend.
When you examine the argument more closely, this fails as a defense of Friedman's analysis. But it raises a broader and more important question. Has the Obama administration's economic team — and by extension, the entire larger orbit of economists relied on by the Democratic Party — wrongly given up on supercharged economic growth?
The debate underscores a change that's taken place slowly and quietly in the party's wonkosphere over the past five years.
There's been a shift from frustration that Congress won't let the president enact his awesome growth-boosting agenda to a view that we are doing about as well as we could be. These days, the White House's favorite economic policy stories aren't favorable coverage of its exciting forward-looking plans but stories like Michael Grunwald's "Everything Is Awesome," "Seriously, Everything Is Pretty Awesome," and "Everything Is (Even More) Awesome!" which declare victory in the war on recession and stagnation.
But are things truly awesome, or are they just okay? What's worse, is it possible that Democrats trying to justify their economic performance have lost sight of the difference?
Gerald Friedman and the output gap
The crucial defense of Friedman's paper comes from this chart, composed by Matthew Klein, which shows that Friedman-level growth would simply return the US economy to its pre-2007 trend level by the end of Sanders's second term.
Obviously there's no guarantee that Sanders's program would actually accomplish this. But Klein's chart raises the question of whether it really makes sense to snippily dismiss the goal as somehow obviously unrealistic — which is more or less what Friedman's (and Sanders's) critics have done.
Everyone agrees that a depressed economy can see growth return to its long-term trend level. Viewed this way, Friedman is simply saying that Sanders's agenda will be adequately stimulative to get the economy back on track and close the "output gap" — the gap between what the economy is producing right now and what it could be producing if all its resources were fully employed.
Friedman's problem: Economic stimulus isn't a time machine
As a narrow defense of Friedman's specific paper arguing for specific effects from Sanders's specific policies, this is not really persuasive.
There are many small nits one could pick with his analysis, because what he essentially does is choose optimistic assumptions at every possible turn, but there are two really big problems with it.
One is that Friedman assumes there will be no growth-slowing supply-side impacts of any of Sanders's policies initiatives. You don't need to be hostile to Sanders's goals or policies to see that this isn't the case. For example, if you make Social Security more generous while also giving people free health care and raising taxes, some people are going to retire earlier. This is a feature of Sanders' agenda (early retirement is nice), not a bug. But by reducing the number of people in the labor force, it will slow the rate of GDP growth.
Sanders's plan to make college free has the same feature. Reducing the price will increase the number of young people who go to school and decrease the amount of part-time work that college students do.
The other problem is that 2007 was nine years ago, and economic stimulus isn't a time machine.
As University of California economist Brad DeLong puts it, "We can't wave a magic demand wand now and get the recovery we threw away in 2009."
With every year that the economy didn't enjoy rapid convergence to the trend line, we missed out on business investment and public investment that the trend line assumed would happen and lay the foundation for future growth. With every year the unemployment rate stayed elevated, we had people out of a job failing to gain skills and experience that they otherwise would have had. Opportunities missed for this long are, at this point, genuinely missed.
DeLong believes we could have had rapid snapback growth if the government had adopted sufficiently stimulative policies in 2009 or 2010. Reasonable people can disagree about how much of the opportunity has vanished in the subsequent years, but Friedman's implicit argument that none of it has vanished is almost certainly too optimistic.
The bigger question: Could very different policy lead to much faster growth?
What's striking is that the Federal Reserve, which, unlike academic economists loosely affiliated with the Sanders campaign, is actually in a position to do something about it, seems to think that the output gap is now essentially closed. There's nothing we can do on the demand side of the economy to get closer to the old pre-recession trajectory.
That, at least, is the implication of its decision to raise the central bank's benchmark interest rate in December. You raise rates to reduce demand and slow the economy. By raising rates late last year, the Fed was saying the economy was at risk of growing too fast in the near future and producing inflation — a theory that would only make sense if you believed the output gap was tiny or nonexistent.
The Obama administration takes a somewhat different view. Pointing, for example, to the 3.1 percentage point decline in the share of the population that has a job, they still see room for countercyclical policy to boost employment and growth. But not much room. The most recent Economic Report of the President attributed just 0.2 percentage points of the 3.1 percentage point total to cyclical effects:
The lion's share of the decline, they think, represents the aging of the population.
But what's really interesting is the large — and growing — share of the gap that they attribute to a mysterious "residual" not identified as the business cycle weakness by their statistical methods.
A conservative critic of the Obama administration, like Casey Mulligan, author of The Redistribution Recession, would likely argue that this residual reflects the malign influence of Obama-era taxes and welfare state expansion, which have blunted people's incentive to work. Conversely, a believer in Friedman-style demand-led growth would say that the White House economists are simply selling stimulus short — we had a collapse in demand that's never been adequately made up, and at the same time we've seen an increase in the number of able-bodied people who aren't working. There's no mysterious residual here, just poor management of the business cycle that better policy could overcome.
The specter of secular stagnation
A perhaps surprising source of support for Sanders's general view of the situation — though presumably not his candidacy — is Larry Summers, formerly Treasury secretary under Bill Clinton and National Economic Council chair under Obama.
Summers has been a hate figure for the progressive wing of the Democratic Party for more than a decade now, and they scuttled his potential nomination to replace Ben Bernanke at the head of the Fed. But in recent years he's developed the view that the entire world economy is suffering from what he calls "secular stagnation" — a persistent shortfall in demand that is reflected in the combination of slow growth, low interest rates, and low inflation currently seen in the United States, Japan, the United Kingdom, and the European Union.
Summers's solution to this problem would fit very nicely in the Sanders playbook:
Traditional concern with fiscal deficits has focused on their impact in pushing up interest rates and retarding investment. Yet by setting yields so low and bond prices so high, markets are sending a clear signal that they want more, not less, government debt. By stimulating growth and enabling an inflation increase that would permit a reduction in real capital costs, fiscal expansion now would crowd investment in rather than out. Well-intentioned proposals to curtail prospective pension benefits, in contrast, might make matters even worse by encouraging increased saving and reduced consumption, thus exacerbating secular stagnation.
The main constraint on the industrial world’s economy today is on the demand, rather than the supply, side. This means that measures that increase potential supply by promoting flexibility are therefore less important than measures that offer the potential to increase demand, such as regulatory reform and business tax reform. Other structural policies that would promote demand include steps to accelerate investments in renewable technologies that could replace fossil fuels and measures to raise the share of total income going to those with a high propensity to consume, such as support for unions and increased minimum wages. Thus, John Maynard Keynes, writing in a similar situation during the late 1930s, rightly emphasized the need for policy approaches that both promoted business confidence—the cheapest form of stimulus—and increased labor compensation.
In a somewhat similar vein, Narayana Kocherlakota, until recently the president of the Minneapolis Federal Reserve Bank, argues that not only are interest rates low, but the share of total national income accruing to workers is also abnormally low.
This combination of cheap capital and cheap labor means, according to Kocherlakota, that there "is no technological reason why real gross domestic product (GDP) cannot grow at a materially above-normal rate over the next decade."
But it won't just happen by magic or good luck. Public policy would need to deliberately try to foster catch-up growth, most likely through a combination of stimulative fiscal policy and a Federal Reserve willing to let wages rise faster than labor productivity in order to make up the lost ground in the labor share of national income.
Sanders has not exactly endorsed this idea, but he has stood out from the crowd by calling for a more pro-growth Federal Reserve and is certainly the candidate in the field who seems most likely to want to try a range of aggressive economic policies.
A debate worth having
In this way, Friedman's somewhat silly paper has managed to spark a debate over a critically important issue that's been largely absent from the Democratic primary: What, if anything, can be done to accelerate economic growth, at least in the short term, and make up some of the ground lost during the Great Recession?
Sanders's economic policy proposals are not really framed as stimulus in this way, and Friedman's case for their stimulative impact is likely overrated.
But while the Clinton campaign has been happy to revel in criticism of Friedman's work, it hasn't come out with its own better and more rigorous plan for boosting growth. The Obama administration, meanwhile, has largely given up on blaming congressional Republicans for blocking growth-boosting measures and simply turned to touting the real, albeit limited, success of the current recovery. Promising to raise the growth rate to 5 percent on an ongoing basis looks ridiculous, but aiming for that kind of catch-up over a year or two, though difficult to pull off, isn't a crazy idea at all.
At a time of nearly unprecedented mass discontent with established political leaders and institutions, in other words, the mainstream Democratic Party is going with the message that things right now are about as good as they're going to get.