Simon Wren-Lewis wrote an interesting article yesterday The Interest Rate Lower Bound Trap and the ideas that keep us there
Unfortunately, the ideas that keep us plugging pointlessly at monetary policy are not that dissimilar to the ideas which will push us into trying fiscal policy: both of them are based on using the old industrial model of labor and capital income distribution which is much less suitable in the digital age where technology takes center stage.
What particularly caught my attention was the 3rd paragraph and this very relevant question: “If these countries really did have a zero output gap, then why is inflation below target?” Which gets to the core of the issue about how technology has possibly substantially increased potential output.
Yet, our models do not fully capture that. Perhaps that is because we continue to put too much weight on capital and labor in the production function when clearly technology has marginalized them both, the evidence being in zero rates and flat wages.
Let’s take capital.
1) there is a large corporate capital surplus;
2) digital technology does not require so much capital;
3) consumer debt is maxed out.
All three of the above lead to low demand for credit meaning low interest rates regardless/independent of monetary policy.
So, after years of zero/negative/low rates (decades in Japan) it is finally obvious that the monetary transmission mechanism is now clogged (see above). Naturally, despite all the opposition, we are probably just a recession away to switching to fiscal policy.
But as labor’s turn comes, there is no guarantee and zero evidence (see, again, Japan) that fiscal policy would work as its transmission mechanism is probably also clogged. And the reason can be found in the fact that it is easier for corporates to switch from labor to technology in automating production.
That’s where the debate about technological unemployment comes in. And here I am in the camp believing that this time things are different because technology is more advanced and is taking away ‘IQ’ jobs in addition to just ‘brawn’. ‘EQ” jobs are humans’ last call of resistance but maybe not for too long.
Sure, no evidence of this for now but that’s because in the initial stages, with aggregate demand low, companies will choose to focus on cost reduction by using cheaper labor (taking advantage of the threat of automation keeping a lid on wages), than higher output/higher productivity using technology.
We’ve had jobless recoveries before but post GFC’08, we’ve had a ‘wageless’ recovery – plenty of jobs but anaemic wages. Neither is particularly good for aggregate demand as individual purchasing power barely increases.
The situation is even worse now as consumer debt to disposable income keeps rising (people now need two jobs to survive).
In the short run, we could potentially see a rise in wages as the labor pool gets gradually depleted, but the switch to automation would also be faster which would push unemployment up/wages back down. In the long run, technology substitution becomes inevitable as both its cost continues to decline and its capabilities to rise.
And, by the way, we are not helping, as apparently we are also getting dumber (see “Were the Victorians cleverer than us?” by M. Woodley et all).
So, the most obvious fiscal policy stimulus is infrastructure spending. That’s much easier to get voted in given the state of our roads and bridges, etc., and the fact that there are probably already too many people shuffling papers on desk jobs working for the government.
Infrastructure spending could be the most economically beneficial option but could also contribute the least to aggregate demand if it bypasses labor due to automation: awarding a billion $ contract to a company to renovate a bridge using mostly automated machinery is hardly going to increase labor’s purchasing power.
My feeling is fiscal policy will indeed soon become the default option. Sadly, not necessarily because it would work better overall for increasing aggregate demand but simply because it has become plain obvious that monetary policy is powerless.
Instead, we need to think ‘beyond the Overton Window’. The income transmission mechanism which we have adopted since the first industrial revolution, Work->Job->Income is broken. Monetary and fiscal policy thus become redundant. We need a new model more suitable for the digital age.