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> Seven Unsustainable Processes
>
>
> Medium-Term Prospects and Policies
> for the United States and the World
>
> Wynne Godley
>
> The U.S. economy has now been expanding for nearly eight years, the budget is in
> surplus, and inflation and unemployment have both fallen substantially. In
> February the Council of Economic Advisers (1999) forecast that GDP could grow by
> 2.0 to 2.4 percent between now and the year 2005, and this forecast has since
> been revised upwards (Office of Management and Budget 1999). Many people share
> the CEA's optimistic views. For instance, in his New Year message (Financial
> Times, December 29, 1998) Alan Blinder compared the United States's economy to
> one of its mighty rivers--it would "just keep rolling along"; and President Bill
> Clinton concluded his Economic Report of the President with the words "There are
> no limits to the world we can create, together, in the century to come." This
> paper takes issue with these optimistic views, although it recognizes that the
> U.S. economy may well enjoy another good year or two.
>
> During the last seven years a persistently restrictive fiscal policy has
> coincided with sluggish net export demand, so rapid growth could come about only
> as a result of a spectacular rise in private expenditure relative to income.
> This rise has driven the private sector into financial deficit on an
> unprecedented scale. The Congressional Budget Office (CBO) is projecting a rise
> in the budget surplus through the next 10 years, conditional on growth's
> continuing at a rate fast enough to keep unemployment roughly constant, and this
> implies that it is government policy to tighten its restrictive fiscal stance
> even further (Congressional Budget Office 1999a, 1999c). At the same time, the
> prospects for net export demand remain unfavorable. But these negative forces
> cannot forever be more than offset by increasingly extravagant private spending,
> creating an ever-rising excess of expenditure over income.
>
> If spending were to stop rising relative to income without there being either a
> fiscal relaxation or a sharp recovery in net exports, the impetus that has
> driven the expansion so far would evaporate and output would not grow fast
> enough to stop unemployment from rising. If, as seems likely, private
> expenditure at some stage reverts to its normal relationship with income, there
> will be, given present fiscal plans, a severe and unusually protracted recession
> with a large rise in unemployment.
>
> It should be added that, because its momentum has become so dependent on rising
> private borrowing, the real economy of the United States is at the mercy of the
> stock market to an unusual extent. A crash would probably have a much larger
> effect on output and employment now than in the past.
>
> A long period of stagnation in the United States, still more recession, would
> have grave implications for the rest of the world, which seems to be depending,
> rather irresponsibly, on the United States to go on acting as spender of last
> resort indefinitely.
>
> This paper makes no short-term forecast. Bubbles and booms often continue much
> longer than anyone can believe possible and there could well be a further year
> or more of robust expansion. The perspective taken here is strategic in the
> sense that it is only concerned with developments over the next 5 to 15 years as
> a whole. Any recommendations regarding policy do not have the character of
> "fine-tuning" in response to short-term disturbances. They ask, rather, whether
> the present stance of either fiscal or trade policy is structurally appropriate
> looking to the medium- and long-term future.
>
> A sustained period of stagnation or recession, through its adverse effect on the
> national income, could drive the budget back into deficit without there being
> any relaxation of policy, yet to counteract an endemic recession, it will be
> necessary to relax fiscal policy, making any emerging deficit even larger.
> Further relaxation of monetary policy could not sustain the expansion, except
> temporarily and perversely by giving a new lease on life to the stock market
> boom. While a relaxation in the stance of fiscal policy will ultimately have to
> be made, this by itself will not be enough to generate balanced growth in the
> medium term because, as matters stand, this would be accompanied by a continuing
> rise in the United States's external deficit and indebtedness. There is probably
> no way in which sustained and balanced growth can be achieved in the medium term
> except through coordinated fiscal expansion worldwide.
>
> The difference between the consensus view and that put forward here could not
> exist without a profound difference in the view of how the economy works. So far
> as the author can observe, the underlying theoretical perspective of the
> optimists, whether they realize it or not, sees all agents, including the
> government, as participants in a gigantic market process in which commodities,
> labor, and financial assets are supplied and demanded. If this market works
> properly, prices (e.g., for labor and commodities) get established that clear
> all markets, including the labor market, so that there can be no long-term
> unemployment and no depression. The only way in which unemployment can be
> reduced permanently, according to this view, is by making markets work better,
> say, by removing "rigidities" or improving flows of information. The government
> is a market participant like any other, its main distinguishing feature being
> that it can print money. Because the government cannot alter the market-clearing
> price of labor, there is no way in which fiscal or monetary policy can change
> aggregate employment and output, except temporarily (by creating false
> expectations) and perversely (because any interference will cause inflation).
>
> No parody is intended. No other story would make sense of the assumption now
> commonly made that the balance between tax receipts and public spending has no
> permanent effect on the evolution of the aggregate demand. And nothing else
> would make sense of the debate now in full swing about how to "spend" the
> federal surplus as though this were a nest egg that can be preserved, spent, or
> squandered without any need to consider the macroeconomic consequences.
>
> The view taken here, which is built into the Keynesian model later deployed, is
> that the government's fiscal operations, through their impact on disposable
> income and expenditure, play a crucial role in determining the level and growth
> rate of total demand and output. The circumstances that have generated a budget
> surplus combined with falling unemployment are not only unusual but essentially
> temporary. No decision to "spend" a surplus can be taken without regard for the
> impact on aggregate demand. In any case, there may soon be no surplus to spend.
>
> This paper first looks at where the current growth has come from, examining, in
> turn, fiscal policy, foreign trade, and private income expenditure and
> borrowing. This examination shows that current growth is associated with seven
> unsustainable processes in the United States: (1) the fall in private saving
> into ever deeper negative territory, (2) the rise in the flow of net lending to
> the private sector, (3) the rise in the growth rate of the real money stock, (4)
> the rise in asset prices at a rate that far exceeds the growth of profits (or of
> GDP), (5) the rise in the budget surplus, (6) the rise in the current account
> deficit, (7) the increase in the United States's net foreign indebtedness
> relative to GDP. The paper then presents a number of medium-term scenarios based
> on models of the United States and world economies, considers some of their
> implications, and discusses appropriate policy responses. The appendixes contain
> notes on the models used and some econometric results.
<<break>>
> About the Author
>
> Wynne Godley is distinguished scholar at the Levy Institute. He is a professor
> emeritus of applied economics at Cambridge University and a fellow of King's
> College. His work at the Levy Institute has centered on the development and
> application of two macroeconomic models, one describing the U.S. economy using a
> consistent system of stocks and flows and the second describing production in
> and trade between 11 country blocs that taken together represent the whole
> world. The models can be used to identify strategic problems, assess the
> implications of alternative policies, and suggest long-term policy responses.
> Godley was a member of HM Treasury's Panel of Independent Forecasters, known as
> "The Six Wise Men."
>
> The Jerome Levy Economics Institute is publishing this proposal with the
> conviction that it represents a constructive and positive contribution to the
> discussions and debates on the relevant policy issues. Neither the Institute's
> Board Of Governors nor its Board Of Advisors necessarily endorses the proposal.
>
> © Copyright 1999 by The Jerome Levy Economics Institute.
A<>E<>R
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