Chapter 28: The Structural Stagnation Policy Dilemma

Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint why they sometimes collide with a bit of reality against which they are dashed to pieces. — Sigmund FreudThe Structural Stagnation Policy DilemmaCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsDifferentiate a structural stagnation from a standard recessionDemonstrate in the AS/AD model how globalization can mask inflationary pressures caused by expansionary policiesExplain the role of globalization and the financial bubble in creating a structural stagnation problemOutline the policy choices that policy makers have to deal with structural stagnationThe Structural Stagnation HypothesisIn December 2007 the U.S. economy fell into a prolonged period of slow growth and stagnation that was not a normal recessionThe structural stagnation hypothesis sees the recent problem of the U.S. economy directly related to the structural problems caused by globalizationWhy the Assumed Underlying Growth Trend Is Important for PolicyThe biggest change that the structural stagnation hypothesis makes to standard macro theory involves the economy’s assumed growth rate in a recoveryThe standard macro policy assumption is that an economy will quickly get back to its long-run trend growth rateStructural stagnation assumes that the adjustment will take much longer, perhaps decadesStructural stagnation explains the decreased effectiveness of expansionary monetary and fiscal policiesThe AS/AD Model with GlobalizationThe globalized AS/AD model adds a world supply curve to the standard AS/AD model to capture the effect that globalization issues can have on an economyNet exports are not part of the standard AS/AD modelThe world supply curve is the amount of tradable goods other countries will supply to the country at a given price level and exchange rateIf domestic producers don’t match world prices, they won’t be able to sell their goodsGlobalization Can Limit Potential OutputIf the world price for goods is below the U.S. price of goods, international competitive forces put a limit on domestic potential outputAccording to the structural stagnation hypothesis, potential output depends on wages, technology, and global competitive conditions as well as physical productive capacityA trade deficit translates into higher unemployment and lower potential output until displaced workers find new jobs in different fields that are competitive in the global economyAggregate Demand Increases No Longer Cause Accelerating InflationIn a globalized economy in which a country can run large trade deficits, expansionary macro policy does not cause inflation but can cause serious short-run structural problemsIncreased demand is channeled into increased imports and demand for assets, creating a financial bubbleThe rise in asset prices makes asset holders feel richer which further increases aggregate demand and amplifies the effect of expansionary fiscal policyThis structural change in the inflation process masked the need in the 1990s and 2000s for real structural adjustmentStructural Problems of GlobalizationGlobalization and EmploymentTo remain employed in the tradable sector the unemployed will have toFind new jobs they can do more cheaply than anyone else in the worldBe willing to accept lower wagesHave access to better technology and capital than do workers in other countries making them more productiveStructural Change in the Nontradable SectorThe inability to continue large U.S. budget deficits will put strong pressure on government to cut government employee wages, benefits, and employmentGlobalization along with expansionary fiscal policy reduces the spending power of those working in the tradable sector in two ways: lower wages and higher costs of livingAccording to the structural stagnation hypothesis the reality is that significant structural change is needed to make the U.S. internationally competitiveGlobalization and Income DistributionStructural problems of globalization involve income distribution and affect different groups of the economy differently The international traders, and workers associated with them, have done phenomenally wellThe unskilled and not highly skilled in the tradable sector are most hurt because they have lost jobs or had wages significantly reducedThose on the nontradable sector who are indirectly affectedThe Future of GlobalizationCountries such as China and India will move up the value-added chain, the movement of trade from natural resources to increasingly complicated goods and servicesCountries at the top of this chain are international traders that experience enormous gains from tradeAs countries move up the value-added chain, the pressures of globalization will feed back on traders, and international traders will find themselves globalized as well; that is a long way in the future Policies to Deal with Short-Run Structural ProblemsGovernment can introduce policies that make it easier for banks to restructure loansGovernment can temporarily rent houses to “underwater” homeowners who otherwise would face foreclosureGovernment can do little about the effects of the decline in wealth caused by the bursting of a bubble without causing new problems down the roadPolicies to Deal with Long-Run Structural ProblemsPolicies that will shift the world supply curve upDecreasing the exchange rateDifferential wage growthTariffs and Trade RestrictionsPolicies to Deal with Long-Run Structural ProblemsPolicies that will shift the SAS curve downLower wagesReduce unemployment insuranceIncreasing U.S. productivity by improving training or increasing resource productionChapter Summary To remain on its growth trend, an economy must grow more in an expansion than it fell during the recessionDuring a structural stagnation, the economy grows more slowly than is needed to return to its trend The U.S. economy today may be experiencing structural stagnation, not a normal downturnThe globalized AS/AD model adds a flat world supply curve, which allows the possibility of a trade deficit that limits a country’s potential outputChapter Summary Globalization with large trade deficits will limit domestic inflation, allowing government to run more expansionary policies than it otherwise wouldGlobalization leads to structural stagnation by creating competition in the tradable goods market which leads to difficult structural adjustmentThe U.S. globalization experience has impacted various groups differentlyStructural stagnation can be resolved if domestic exchange rates fall, domestic wages and other costs fall, or productivity rises