As an economist and former senior federal economic policymaker, I have labeled this prolonged period of below potential economic recovery, “The New Normal.” There are both cyclical (short-term) and fundamental (longer term) factors that suggest a continued period of sluggish economic activity and slow employment growth, unless we change our economic and monetary policy mix.
On the cyclical side, we are still working out the overhang of unsold foreclosed properties and the buildup of private debt that erupted in 2007, leading to the sharpest economic contraction since the Great Depression. In addition, the U.S. economy is laboring against strong “headwinds” this year and possibly in 2013.
Among these cyclical “headwinds” are the deepening recession in the Euro Zone and economic slowdowns in the large emerging markets of China and Brazil. Finally, the bitter U.S. “political season,” with two sharply differing economic philosophies, seems to be affecting business confidence relative to the future direction of fiscal and regulatory policies.
The trillions of dollars of “parked” cash that corporations have, are — in my view — a reflection of so-called “risk aversion” to expanding payrolls at this time of uncertainty in both the political and economic realms.
However, the strong “headwinds” will eventually diminish over the next 12 months or so. Therefore, we are left with the serious fundamental issues that are hamstringing the vigor and dynamism of the U.S. economy.
At this stage of an economic cycle, the economy should be expanding at a 3-percent to 4-percent annual rate, not at the tepid 2 percent or less, as is the case today.
A resolution of these fundamental issues would place the U.S. economy on the path of stronger economic activity and a higher standard of living. From my perspective, the key fundamental issues weighing down on the economy are:
• The federal debt/GDP ratio is on an unsustainable path, with the federal debt held by the public surpassing 100 percent of GDP in a few short years, according to the non-partisan Congressional Budget Office (CBO). If we desire stronger economic and employment growth, we need a market-credible, long-term fiscal plan that places the federal debt/GDP ratio on a declining scale.
We would also need market-credible policies that generate a climate for stronger GDP growth (in essence, growing GDP faster than the growth of federal debt, resulting in a declining federal debt/GDP ratio).
Among pro-growth measures would be serious tax reform such as a flat income tax or a National Consumption Tax (not continued tinkering with the massive and complex current tax code that acts as a “dead weight” cost to the economy).
We would also need “smart” deregulation of economic activity and a rational energy policy based on market factors.
• To improve long-term economic growth, we should rethink and reform how we conduct monetary policy. Financial and asset “bubbles” are primarily the result of “easy money” (low-real interest, or “cheap-priced money”) that causes speculation by financial actors, investors and the general public.
Fed policy was too “easy” for a long period of time after the tragic events of Sept. 11, 2001. In my opinion, misguided monetary policy was one of the leading causes of the subsequent housing and financial “bubbles.” We are still paying the price of such a misguided policy and “working out of” the current housing and debt leverage issues.
In the view of some economists like me, constant tinkering with the monetary base and interest rates are affecting our long-term economic growth potential. For example, the monetary base, due to Fed action, has exploded to $2.6 trillion as of May 2012. This could create an inflationary spiral in the longer term, causing another great recession.
J. Antonio “Tony” Villamil is dean of the business school at St. Thomas University and served as U.S. undersecretary of Commerce for economic affairs during the George H.W. Bush administration.