Eichengreen sees danger in US fiscal stimulus

Powerful government stimulus in the late 1930s helped end a long period of stagnation in the US, but trying the same thing now could prove destabilising, Barry Eichengreen warned on January 16.

Eichengreen told a conference at the Banque de France there was room for improving infrastructure in the US, a policy propounded by president-elect Donald Trump. But now may not be the right time, he said.

The US is close to full employment, the professor of economics noted. In such a situation, government spending will crowd out domestic consumption and manifest in upward pressure on inflation and the US dollar.

Eichengreen said he was not sure emerging markets with dollar funding needs nor the broader global financial system was ready for an even stronger dollar. He also saw flaws in another plank of Trump's economy policy, saying: "I'm not sure the solution [to supply constraints] lies in sweeping deregulation."

He suggested spending on education could be a better option. By helping people retrain, the government could reverse part of the recent decline in labour force participation, which would carry less risk of overheating.

Secular stagnation

The conference was convened to grapple with the causes of the recent downward trend in productivity growth and real interest rates.

Despite Eichengreen's warning on the demand side in the US, a European economist saw the potential for a demand-based solution. Luca Fornaro of Barcelona's CREI suggested a Keynesian explanation, where the economy can become stuck in a bad equilibrium, requiring stimulus to escape.

Fornaro recommended action on investment, namely some form of subsidy to investment spending. Central banks can also help if they can commit to a suitably low future path of interest rates, his research finds.

Northwestern University's Robert Gordon turned to the supply side, suggesting the IT-driven boom of the 1990s was less of a revolution than it may have seemed. Compared with productivity growth from innovations in the mid-20th century, the benefits of IT seem to have proven small and transitory.

Adopting innovations can take a long time, leading to lags in productivity growth, said Nicholas Crafts of the University of Warwick. It takes time for people to adapt to new techniques, so the productivity dividend could come later. Eichengreen said he was also hopeful this could happen.

Research by the Banque de France's Benoit Mojon seeks to break down the factors behind low real rates. Mojon's paper finds that a shortage of safe assets is a major factor, with contributions from demographic change and productivity problems.

Earlier in the day, a group of economists discussed the possibility of measurement errors being at play, though they concluded it could only be part of the explanation.