Lecture Economics (9/e): Chapter 28 - David C. Colander

Chapter 28 - The structural stagnation policy dilemma. After reading this chapter, you should be able to: Differentiate a structural stagnation from a standard recession, demonstrate in the AS/AD model how globalization can mask inflationary pressures caused by expansionary policies, explain the role of globalization and the financial bubble in creating a structural stagnation problem, outline the policy choices that policy makers have to deal with structural stagnation.

Introduction:  Thinking Like an Economist CHAPTER  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 Freud McGraw­Hill/Irwin Copyright © 2013 by The McGraw­Hill Companies, Inc. All rights reserved The Structural  Stagnation Policy  Dilemma 28 Chapter Goals Ø Ø Ø Ø Differentiate a structural stagnation from a standard recession Demonstrate in the AS/AD model how globalization can mask inflationary pressures caused by expansionary policies Explain the role of globalization and the financial bubble in creating a structural stagnation problem Outline the policy choices that policy makers have to deal with structural stagnation 28­2 The Structural  Stagnation Policy  Dilemma 28 The Structural Stagnation Hypothesis Ø Ø In December 2007 the U.S economy fell into a prolonged period of slow growth and stagnation that was not a normal recession The structural stagnation hypothesis sees the recent problem of the U.S economy directly related to the structural problems caused by globalization 28­3 The Structural  Stagnation Policy  Dilemma 28 Why the Assumed Underlying Growth Trend Is Important for Policy Ø The biggest change that the structural stagnation hypothesis makes to standard macro theory involves the economy’s assumed growth rate in a recovery • • Ø The standard macro policy assumption is that an economy will quickly get back to its long-run trend growth rate Structural stagnation assumes that the adjustment will take much longer, perhaps decades Structural stagnation explains the decreased effectiveness of expansionary monetary and fiscal policies 28­4 The Structural  Stagnation Policy  Dilemma 28 The AS/AD Model with Globalization Ø Ø Ø The 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 economy Net exports are not part of the standard AS/AD model The world supply curve is the amount of tradable goods other countries will supply to the country at a given price level and exchange rate • If domestic producers don’t match world prices, they won’t be able to sell their goods 28­5 The Structural  Stagnation Policy  Dilemma 28 Globalization Can Limit Potential Output Ø Ø Ø If the world price for goods is below the U.S price of goods, international competitive forces put a limit on domestic potential output According to the structural stagnation hypothesis, potential output depends on wages, technology, and global competitive conditions as well as physical productive capacity A 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 economy 28­6 The Structural  Stagnation Policy  Dilemma 28 Aggregate Demand Increases No Longer Cause Accelerating Inflation Ø In 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 problems • • Ø Increased demand is channeled into increased imports and demand for assets, creating a financial bubble The rise in asset prices makes asset holders feel richer which further increases aggregate demand and amplifies the effect of expansionary fiscal policy This structural change in the inflation process masked the need in the 1990s and 2000s for real structural 28­7 The Structural  Stagnation Policy  Dilemma 28 Structural Problems of Globalization Globalization and Employment Ø To remain employed in the tradable sector the unemployed will have to • • • Find new jobs they can more cheaply than anyone else in the world Be willing to accept lower wages Have access to better technology and capital than workers in other countries making them more productive 28­8 The Structural  Stagnation Policy  Dilemma 28 Structural Change in the Nontradable Sector Ø Ø Ø The inability to continue large U.S budget deficits will put strong pressure on government to cut government employee wages, benefits, and employment Globalization 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 living According to the structural stagnation hypothesis the reality is that significant structural change is needed to make the U.S internationally competitive 28­9 The Structural  Stagnation Policy  Dilemma 28 Globalization and Income Distribution Ø Structural 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 well The unskilled and not highly skilled in the tradable sector are most hurt because they have lost jobs or had wages significantly reduced Those on the nontradable sector who are indirectly affected 28­10 The Structural  Stagnation Policy  Dilemma 28 The Future of Globalization Ø Ø Ø Countries such as China and India will move up the valueadded chain, the movement of trade from natural resources to increasingly complicated goods and services Countries at the top of this chain are international traders that experience enormous gains from trade As 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 28­11 The Structural  Stagnation Policy  Dilemma 28 Policies to Deal with Short-Run Structural Problems Ø Ø Ø Government can introduce policies that make it easier for banks to restructure loans Government can temporarily rent houses to “underwater” homeowners who otherwise would face foreclosure Government can little about the effects of the decline in wealth caused by the bursting of a bubble without causing new problems down the road 28­12 The Structural  Stagnation Policy  Dilemma 28 Policies to Deal with Long-Run Structural Problems Policies that will shift the world supply curve up Decreasing the exchange rate Differential wage growth Tariffs and Trade Restrictions 28­13 The Structural  Stagnation Policy  Dilemma 28 Policies to Deal with Long-Run Structural Problems Policies that will shift the SAS curve down Lower wages Reduce unemployment insurance Increasing U.S productivity by improving training or increasing resource production 28­14 The Structural  Stagnation Policy  Dilemma 28 Chapter Summary Ø Ø Ø Ø To remain on its growth trend, an economy must grow more in an expansion than it fell during the recession During 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 downturn The globalized AS/AD model adds a flat world supply curve, which allows the possibility of a trade deficit that limits a country’s potential output 28­15 The Structural  Stagnation Policy  Dilemma 28 Chapter Summary Ø Ø Ø Ø Globalization with large trade deficits will limit domestic inflation, allowing government to run more expansionary policies than it otherwise would Globalization leads to structural stagnation by creating competition in the tradable goods market which leads to difficult structural adjustment The U.S globalization experience has impacted various groups differently Structural stagnation can be resolved if domestic exchange rates fall, domestic wages and other costs fall, or productivity rises 28­16 ... bursting of a bubble without causing new problems down the road 28 12 The Structural  Stagnation Policy  Dilemma 28 Policies to Deal with Long-Run Structural Problems Policies that will shift the world... Differential wage growth Tariffs and Trade Restrictions 28 13 The Structural  Stagnation Policy  Dilemma 28 Policies to Deal with Long-Run Structural Problems Policies that will shift the SAS... productivity by improving training or increasing resource production 28 14 The Structural  Stagnation Policy  Dilemma 28 Chapter Summary Ø Ø Ø Ø To remain on its growth trend, an economy must