We are all Conservatives Now

We are all conservatives now! I knew that would get your attention. No, I am not into my third JD of the evening. But something is going on out there – or not going on out there – that supports my wild contention.

First, I am focused on financial conservatism – not the social variety. Second, I am speculating about conservatism as it plays out in macroeconomics policy. This idea has been ruminating in the dark recesses of my brain and jumped to the surface this week after I read one brief article online worrying over the uncertainty about US policy under Trump and then read another lengthier piece about the global economy by the International Monetary Fund.

The shorter Bloomberg article thought that stalling new policies for infrastructure spending and tax reform would injure corporate profits and lead to a slower economy. The IMF piece – a magnum opus on the world’s future output growth published this month – was more sanguine and predicted that the world and US economies would grow faster in 2017 and 2018. http://www.imf.org/en/Publications/WEO/Issues/2017/04/04/world-economic-outlook-april-2017

These two recent pieces see different futures but agree on one thing – it is the lack of traditional policy that underlies our economic futures. In macro, we learn two opposing schools of thought. The conservative macros believe good macro outcomes are the result of less government intervention. The liberal macros believe the opposite. The liberal macros believe that activism known as monetary and fiscal policy are necessary to rev up spending and will lead to full employment and strong economic growth. This liberal belief has become traditional. 

While the IMF often shows a liberal tilt in their outlook reports, much of what they say in the April installment is lacking in liberal spirit. From this I conclude that we are in a new economic policy conservative era – at least for a while.

While the IMF is forecasting marginal improvements in economic growth around the world, they mostly see an economy stuck in neutral and not ready for the next drag race. Summarizing from a long and technical report, the IMF describes an economy hampered by dismal expectations. The usual monetary and fiscal policies are having little effect on spending, and the more they fail to work, the more pessimistic we become. And therefore the policies have even less impact and we become even more dismal.

Low and negative interest rates spurred some activity in housing and autos but firms are sitting on their hands when it comes to expansions and modernization. Despite record amounts of fiscal stimulus, there is little bump to spending in the economy. The more the government lingers with these policies, the more dismal people become. The IMF wishes that governments could magically raise optimism. But how do you do that when the usual policies are not working?

What is refreshing is that the IMF is recommending some very conservative policies—policies that could be called supply-side. Imagine that. They admit that government is out of bullets. In fact they admit that there is already too much money outstanding and too little fiscal space (too much high debt) for most countries to resort to the usual policy practices.

The IMF names two major trends that are holding back the advanced countries. The first is a decline in the labor force participation rate. People are not wanting to work as much as in the past. Various reforms could help on that score but these reforms have nothing to do with the usual macro policies. They focus on the reward to work and on labor market mismatches. The second major challenge is in firms' willingness to buy new capital and to innovate. Firms are reluctant because of a dismal outlook but there are many ways that government can try to raise the return to capital without resorting to demand management. Reforms with respect to regulations and tax rates could go a long way to creating a more sanguine future for business firms. Raising the reward to work and to buy new capital will make firms more productive and profitable and should improve the growth rate of the economy. 

In addition to these trends are two global factors that dent our ability to grow faster. The first is recovery and reform in China. As these reforms start to work, China will resume its role as a locomotive pulling the rest of us along with them. Finally, there are the lingering impacts of commodity and energy prices. While we all love a low price of gasoline, the low prices of energy have stunted exploration and development of oil and gas. Emerging markets prospered with high energy and commodity prices. They tanked with low ones, and the contagion was global. 

None of the above supports a role for the usual liberal macro policies of monetary accommodation or fiscal expansion. In fact, making people more optimistic might involve admitting the ineffectiveness of these old tools – and thus we come away thinking that monetary normalcy and budgetary restraints are the key to optimism and spending. But better than that is the simple idea that policy should fit the nature of our problems. Right now our problems are from the supply side. Demand is low BECAUSE supply is low and because global challenges add to an uncertain outlook. Policies that directly target supply issues are what the IMF is recommending. What a refreshing change of message!