Thinking clearly about demand declines -- and what to do about them
Tyler Cowen's post separating types of demand problems is really worth reading. There are at least three ways in which demand can decline, he says, and each suggests different solutions.
The first is the most basic: Spending goes down for a bit. You can fix that with stimulus.
The second is also intuitive, but more worrying: Spending readjusts to a permanently lower level. That one is harder to fix. You need to make people wealthier again, or shift your economy away from consumption.
The third is a bit more complicated: Demand for certain items -- say, consumer goods that people don't necessarily need to purchase -- falls, and you need to wait for people's wealth situation to change or for them to wear holes in their shoes.
The economy, of course, can experience all three. The chaos of the initial financial crisis pushed spending way below the level we could support, and so stimulus made perfect sense as a way to close the gap between where demand was and where it should've been. But in the aftermath of the credit bubble, we really are less rich than we thought we were. We can't support the debt-based consumption that drove the economy in the early-years of the century. That requires thinking about the economy somewhat differently. It requires a long-term strategy.
The stimulus actually had some of this. There were a raft of policies investing in green technology, high-speed rail, medical research, health information technology, education and other areas that won't pay off in the next year or so, but are meant to help birth new industries and generate a more stable economic foundation in the future. Those policies are now being attacked because they didn't spend out as quickly as the tax cuts, but I consider them economically wise, even if they were politically unwise.
What I'd really like to be talking about right now are long-term proposals to help deal with long-term growth. Things such as early-childhood education, a permanent extension of the R&D tax credit, a large investment in our public universities (particularly given the cuts they're experiencing right now), much more attention to retraining, and so on. But the opposite is happening, and short-term economic and political considerations are actually handicapping long-term policies: States are cutting school funding and various Republican senators are trying to divert unspent money in the stimulus bill's long-term investments to deficit reduction.
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