Macroeconomic Policy Challenges

MacroeconomicPolicyChallenges

KarenDynanProfessorofthePractice,HarvardUniversityEconomicsDepartment

EconomicsDepartmentAlumniReceptionMay26,2018

Notesforslidesareattheendofthepresentation.

Aboutme

5/26/18 Macroeconomic Policy Challenges - Dynan 1

HarvardUniversityEconomicsDepartment

FederalReserveBoard

Brookings Institution

U.S.TreasuryDepartment

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• Backdrop:strongshort-termgrowth

• Challenge1:risingfederaldebt

• Challenge2:weakproductivitygrowth

• Challenge3:riskofrecession

• Policyimplications

5/26/18 MacroeconomicPolicyChallenges- Dynan 2

Talktoday







Healthylabormarket


0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010

U.S.Unemployment RatePercent oflaborforce

Source:U.S.DepartmentofLabor.Shadedbars denoterecessions.

Lowinflation


-2

0

2

4

6

8

10

12

1970 1980 1990 2000 2010

Consumer PricesPercent change from year earlier

Source. U.S. Department of Commerce.

Overall

Excluding food and energy

2 percent (Fed's goal)

StrongGDPoutlookfor2018


0

1

2

3

4Percent (annual rate)

Average GDP growth last 25

years

Projections for 2018 GDP growth (Q4/Q4)

WSJforecaster

survey(May 2018)

IMF(April 2018)

Federal Reserve

(March 2018)

CBO(April 2018)

Whyistheeconomystrong?

“Synchronized”globalupswing

Financialconditionsandmonetarypolicystillsupportive(onnet)

Businessandconsumerconfidenceishigh

Fiscalstimulus


Bigdemandboostfrombothtaxesandspending


800

900

1000

1100

1200

1300

1400

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

CBO June 2017 projectionCBO April 2018 projection

Federal Discretionary SpendingBillions of dollars

Source: Congressional Budget Office.

-2.00

-1.50

-1.00

-0.50

0.00

0.50

FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY26 FY27

International

Corporate

Individual

Total

Change in Tax Payments from 2017 Tax Act

Percent of GDP

Source: Author's calculations based on JCT and CBO data.

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• Policyideas


Risingfederaldebt


0

20

40

60

80

100

120

2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027

U.S. Federal Debt Held by the PublicPercent of GDP

Source. Congressional Budget Office (2018).

Actual Projected

Risingfederaldebt(longview)


0

20

40

60

80

100

120

1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010

U.S. Federal Debt Held by the PublicPercent of GDP


ProjectedActual

World War II

GreatDepression

World War ICivil War

The2017taxactraisesfederaldebt


0

1

2

3

4

5

6

7

Effect of 2017 Tax Act on Federal Debt in 2027In percentage points

Source: Brookings-Urban Tax Policy Center (2017).

with no macro

feedback

with macro

feedback

6.3

5.5

Biggerissue—populationaging


0

50

100

150

200

250

300

1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 2018 2023 2028

U.S. Population by Age GroupMillions of people

Source: Congressional Budget Office (2018).

Ages 20 to 64

Age 65 or older

Actual Projected


Increaseindeficitdrivenbyhigherspendingonolderpopulation,healthcare,interest

0

5

10

15

20

25

30

Evolution of the Federal Budget over TimePercent of GDP

Source. Congresssional Budget Office (2018).

SocialSecurity

Major HealthCare

Programs

OtherNoninterest

DeficitNet Interest

Spending Revenues

------- 1993 -------- -------- 2018-------- -------- 2028 --------

Evenwithoutadebtcrisis,wewillsee…

Crowdingout ofprivateinvestment

Pressuretocutdiscretionaryspending

InsufficientfinancingforSocialSecurityandMedicarebenefitsasscheduled


KeyprojectionsforSocialSecurityandMedicare

SocialSecurity:

OASItrustfundwillrundryin2035

%ofprojectedbenefitspayableafterthat:75percent

Medicare:

Hospitalinsurancetrustfundwillrundryin2029

%ofprojectedcostsfundableafterthat:88percent

Source:2017reportsfromthetrusteesoftheSocialSecurityandMedicaretrustfunds.


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Whatisproductivity?

Especiallyimportanttothemacropicturegiventhatgrowthinthelaborforcehasslowedbecauseofpopulationaging,womennolongersurgingintothelaborforce,andothertrends

1.8%=annualgrowthlaborforce1970-19990.5%=CBO’sprojectionfornext10years


productivity=outputperhour

Productivityhasdisappointedinrecentyears


0

1

2

3

4

1975 1985 1995 2005 2015

Labor Productivity GrowthAnnualized percent change, 5-year moving average

Source. U.S. Department of Labor.

NotjustaU.S.challenge


0

1

2

3

4

1975 1985 1995 2005 2015

Labor Productivity Growth in G-7 CountriesAnnualized percent change, 5-year moving average

Source. OECD.

Not(primarily)ameasurementissue


Unpackingtheslowergrowth


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Composition of U.S. Productivity GrowthPercentage points, annual rate

1950-1973 1974-1995 1996-2003 2004-2017Source. U.S. Labor Department.

Capital deepening

TFP growth

Labor quality

Importantimplicationsforthestandardofliving


Whathappensifyouproject2016medianhouseholdincomeforward10yearswiththeproductivitygrowthratewesawfrom1950-73?

Withtheratewesawfrom2004-17?

MedianHouseholdIncomein2026AssumingDifferentGrowthRates

2.9% 1.4%

2016dollars

~$67,800

~$78,600

assumed annualgrowth

Importantimplicationsforthebudgetpicture


0

40

80

120

160

200

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045

Federal Debt Given Different Productivity Growth AssumptionsPercent of GDP

Source. Congressional Budget Office (2017). Assumes fiscal policy as of March 2017.

Productivity grows 1/2 percentage point per year more slowly than the baseline rate

Productivity grows at baseline rate

176

150

Actual Projected

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Thecurrentexpansionhasbeenverylong


12 14 138

35

12

20

4

31

40

24

36

0

10

20

30

40

1945–1948

1949–1953

1954–1957

1958–1960

1961–1969

1970–1973

1975–1980

1980–1981

1982–1990

1991–2001

2001–2007

2009–present

Duration of Economic Expansions since 1945Quarters


Whatcouldderailtheeconomy?

Tradewar

“Overshooting”offullemploymentthatleadstoinflationarypressures,that,inturn,leadtheFedtoraiseinterestratesmoresharplythancurrentexpected

Financialmarketpullbackarisingfromgeopoliticalevents,financialinstabilityabroad,valuationsthatmaybehightoday


Theproblem:limitedmacroeconomictoolstomitigatethenextrecession

Alreadyhighlevelsoffederaldebtlimitscopeforloweringtaxesorincreasinggovernmentspendingtoincreasedemand

The“zero-lower-bound”problemwillcontinuetobeanobstacleformonetarypolicybecauseoftheseculardowntrendininterestrates


Interestrateshavefallenconsiderablyovertime


0

5

10

15

20

1955 1965 1975 1985 1995 2005 2015

U.S.InterestRatesPercent

Source.Federal ReserveBoard.

10-year Treasuryrate

Fed's policy rate

Interestratesshouldriseasmonetarypolicynormalizesbutnotbymuch


FOMCParticipants’ProjectionsforFederalFundsRatePercent

2018 2019 2020 Longerrun

Implyingmuchlessroomtolowerratesthaninearlierdownturns


Rateswerecutbymorethan5percentinlast3recessions:

SoweshouldbeconcernedthatthemedianFOMCparticipantseesthefedfundsratestabilizingatcloseto3percent.

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GettoworknowonSocialSecurity

Changesareusuallyphasedinslowly

Desiredpolicychangesmaybeaffectedbydifferentexperiencesinrecentdecadesforhigher- andlower- incomepeopleregardingwagegrowthandchangesinlifeexpectancy


Maintainpublicinvestmentspending


0

2

4

6

8

10

12

14

1968 1978 1988 1998 2008 2018 2028

U.S. Federal Discretionary SpendingPercent of GDP


Actual Projected

Takestepstoboostworking-agelaborforceparticipation


20

40

60

80

100

1950 1960 1970 1980 1990 2000 2010

Participation Rates for Workers Age 25-54Percent

Prime-age male labor force participation has been trending down for decades

The rise in prime-age female labor force participation has stalled

Source. U.S. Labor Department.

Considerregulatoryobstaclesthatmaybereducingdynamism


0

5

10

15

20

25

0

10

20

30

40

50

60

1982 1987 1992 1997 2002 2007

Percent Percent

Share of employment from young firms (right axis)

Source. Decker, Haltiwanger, Harmin, and Miranda (2014).

Share of firms that are young (left axis)

Changing Role of Young Firms (Age 5 or Less)

Useandrefinealternativemonetarypolicytools

Don’tbesqueamishaboutquantitativeeasing

Evidencesuggeststhatitworked

Exploreanddevelopothertools

Forwardguidance?Shouldwegofurtheranduserules?

Negativeinterestrates?Canweovercomethepracticalandpoliticalobstacles?

RaisetheFed’stargetinflationrate?Woulditunanchorinflationexpectations?


Questions?


NotesSlide4: Quarterlydata;lastdatapointisfor2018:Q1.Slide5: ChartshowconsumerinflationbasedonthePCEpricemeasure,whichispreferredbytheFed.Theseriesaremonthly,andthelast

datapointsareforMarch2018.Slide6: NumbersshowninchartareforrealGDP.TheWallStreetJournalprojectionscanbefoundhere:

http://projects.wsj.com/econforecast/#ind=gdp&r=20;theIMFforecastcanbefoundhere:https://www.imf.org/en/Publications/WEO/Issues/2018/03/20/world-economic-outlook-april-2018;theFederalReserveforecastcanbefoundhere:https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20180321.htm;andtheCBOforecastcanbefoundhere:https://www.cbo.gov/publication/53651.

Slides10,11,13,14:ThesegraphsareallbasedondatafromtheCBO’slatestbudgetandeconomicforecast,whichcanbefoundhere:https://www.cbo.gov/publication/53651.

Slide16:Asummaryofthetrustfundreportscanbefoundat:https://www.ssa.gov/oact/trsum/.Slide18:CBO’s(2018)projectionisavailablehere:https://www.cbo.gov/sites/default/files/recurringdata/51118-2018-04-

budgetprojections.xlsx.Slide19: Chartshowslaborproductivitygrowthforthenonfarmbusinesssector.Slide20: OECDdataareavailablehere:https://www.oecd-ilibrary.org/employment/data/oecd-productivity-statistics/gdp-per-capita-and-

productivity-growth_data-00685-en.ChartshowsaveragegrowthinGDPperhourworked.Slide22: Chartshowsaverageannuallaborproductivitygrowth(anditscomponents)forthenonfarmbusinesssectoroverdifferent

productivity“eras”identifiedbyeconomists.Slide23:MedianhouseholdincomefromtheCensusBureauavailablehere:https://www.census.gov/data/tables/2017/demo/income-

poverty/p60-259.html.(Mostrecentestimateisfor2016.)Slide24:TheCBOlong-termprojectionswerelastpublishedinMarch2017,sotheseriesshownherearebasedonfiscalpolicyasofthat

date.Incorporatingthe2017taxactwouldraisethelevelofbothlinesbyabout5percentagepoints.CBOlong-termprojections areavailablehere:https://www.cbo.gov/sites/default/files/recurringdata/51119-2017-03-ltbo_1.xlsx.TheCBOassumesthatproductivitywillgrowroughly1.6percentagepointsperyearinthebaseline.

Slide34:Thedatacanbefoundhere:https://www.cbo.gov/system/files/115th-congress-2017-2018/reports/53651-dataunderlyingfigures.xlsx.

Slide36: Datafromfigure4ofDecker,Ryan,JohnHaltiwanger,RonJarmin,andJavierMiranda(2014),“TheRoleofEntrepreneurshipinUSJobCreationandEconomicDynamism,”JournalofEconomicPerspectives 28(3).


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Macroeconomic Policy Challenges