Research Topics

A Critical Assessment

During the period leading up to the recession of 2007–08, there was a large increase in household debt relative to income, a large increase in measured consumption as a fraction of GDP, and a shift toward more unequal income distribution. It is sometimes claimed that these three developments were closely linked. In these stories, the rise in household debt is largely due to increased borrowing by lower-income households who sought to maintain rising consumption in the face of stagnant incomes; this increased consumption in turn played an important role in maintaining aggregate demand. In this paper, I ask if this story is consistent with the empirical evidence. In particular, I ask five questions: How much household borrowing finances consumption spending? How much has monetary consumption spending by households increased? How much of the rise in household debt-income ratios is attributable to increased borrowing? How is household debt distributed by income? And how has the distribution of consumption spending changed relative to the distribution of income? I conclude that the distribution-debt-demand story may have some validity if limited to the housing boom period of 2002–07, but does not fit the longer-term rise in household debt since 1980.

From a macroeconomic point of view, 2016 was an ordinary year in the post–Great Recession period. As in prior years, the conventional forecasts predicted that this would be the year the economy would finally escape from the “new normal” of secular stagnation. But just as in every previous year, the forecasts were confounded by the actual result: lower-than-expected growth—just 1.6 percent.
 
The radical policy changes promoted by the new Trump administration dominated economic conditions in the closing quarter of the year and the first quarter of 2017. Markets have responded with exuberance since the November elections, on the expectation that the proposed policy measures would increase profitability by boosting growth and cutting personal and corporate taxes. However, an evaluation of the US economy’s structural characteristics reveals three key impediments to a robust, sustainable recovery: income inequality, fiscal conservatism, and weak net export demand. The new administration’s often conflicting policy proposals are unlikely to solve any of these fundamental problems—if anything, the situation will worsen.
 
Our latest Strategic Analysis provides two medium-term scenarios for the US economy. The “business as usual” baseline scenario (built on CBO estimates) shows household debt and GDP growth roughly maintaining their moribund postcrisis trends. The second scenario assumes a sharp correction in the stock market beginning in 2017Q3, combined with another round of private sector deleveraging. The results: negative growth and a government deficit of 8.3 percent by 2020—essentially a repeat of the crisis of 2007–9. 

Since the 1980s, economic recoveries in the United States have been delivering the vast majority of income growth to the wealthiest households. This policy note updates the analysis in One-Pager No. 47 and Policy Note 2015/4 with the latest data through 2015, looking at the distribution of average income growth (with and without capital gains) between the bottom 90 percent and top 10 percent of households, and between the bottom 99 percent and top 1 percent of households.

Little has changed when considering the distribution of average income growth in the current recovery (up to 2015) between the bottom 90 percent and top 10 percent of families, with or without capital gains. Although average real income for the bottom 90 percent of households is no longer shrinking, these families still capture a historically small proportion of that growth—only between 18 percent and 22 percent. The growing economy continues to deliver the most benefits to the wealthiest families.

Our latest strategic analysis reveals that the US economy remains fragile because of three persistent structural issues: weak demand for US exports, fiscal conservatism, and a four-decade trend in rising income inequality. It also faces risks from stagnation in the economies of the United States’ trading partners, appreciation of the dollar, and a contraction in asset prices. The authors provide a baseline and three alternative medium-term scenarios using the Levy Institute’s stock-flow consistent macro model: a dollar appreciation and reduced growth in US trading partners scenario; a stock market correction scenario; and a third scenario combining scenarios 1 and 2. The baseline scenario shows that future growth will depend on an increase in private sector indebtedness, while the remaining scenarios underscore the linkages between a fragile US recovery and instability in the global economy. 

In this latest Strategic Analysis, the Institute’s Macro Modeling Team examines the current, anemic recovery of the US economy. The authors identify three structural obstacles—the weak performance of net exports, a prevailing fiscal conservatism, and high income inequality—that, in combination with continued household sector deleveraging, explain the recovery’s slow pace. Their baseline macro scenario shows that the Congressional Budget Office’s latest GDP growth projections require a rise in private sector spending in excess of income—the same unsustainable path that preceded both the 2001 recession and the Great Recession of 2007–9. To better understand the risks to the US economy, the authors also examine three alternative scenarios for the period 2015–18: a 1 percent reduction in the real GDP growth rate of US trading partners, a 25 percent appreciation of the dollar over the next four years, and the combined impact of both changes. All three scenarios show that further dollar appreciation and/or a growth slowdown in the trading partner economies will lead to an increase in the foreign deficit and a decrease in the projected growth rate, while heightening the need for private (and government) borrowing and adding to the economy’s fragility. 

Trends in US Income Inequality

In the postwar period, with every subsequent expansion, a smaller and smaller share of the gains in income growth have gone to the bottom 90 percent of families. Worse, in the latest expansion, while the economy has grown and average real income has recovered from its 2008 lows, all of the growth has gone to the wealthiest 10 percent of families, and the income of the bottom 90 percent has fallen. Most Americans have not felt that they have been part of the expansion. We have reached a situation where a rising tide sinks most boats.   This policy note provides a broader overview of the increasingly unequal distribution of income growth during expansions, examines some of the changes that occurred from 2012 to 2013, and identifies a disturbing business cycle trend. It also suggests that policy must go beyond the tax system if we are serious about reversing the drastic worsening of income inequality. 

From Bad to Worse

In a recent policy note (A Decade of Flat Wages?) we examined wage trends since 1994, and found that while wages grew between 1994 and 2002, average real wages stagnated or declined after 2002–03. Our latest study provides a more detailed analysis of wage trends for wage-level, age, and education groups, with emphasis on the periods following the 2001 and 2007–09 recessions.   There was a more or less cohesive evolution of wages among different groups until 2002–03. However, after controlling for structural changes in the labor force, wages diverged sharply in the years that followed for different age, education, and wage groups, with the majority of workers experiencing real declines in their wages. This was not a short-term decline among a few numerically insignificant groups. Nearly two-thirds of all full-time wage earners have less than a four-year college degree and saw their wages decline compared to peak wages in 2002. Workers aged 44 and younger, representing slightly more than 38 million full-time wage earners or 71.4 percent of all full-time wage earners in the United States, also experienced a large reduction in cumulative wage growth after 2002. In terms of wage groups, the bottom 75 percent of full-time workers saw a decline in real wages, while those at the top of the wage distribution saw their wages rise—clear evidence of increasing wage inequality.   Given the downward trend in real wages for the majority of full-time wage earners since 2009, it should come as no surprise that recovery from the Great Recession has been weak. In the absence of an employer-of-last-resort policy, federal and state policy must focus its efforts on increasing wages through measures such as progressive tax policy, raising the minimum wage, ensuring overtime pay laws are enforced, and creating opportunities for the most vulnerable workers.  

In the postwar period, income growth has become more inequitably distributed with virtually every subsequent economic expansion. From 2009 to 2012, while the economy was recovering from one of the biggest economic downturns in recent memory, the top 1 percent took home 95 percent of the income gains. To reverse this pattern, Research Associate Pavlina R. Tcherneva recommends policy strategies to promote growth from the bottom up—to change the income distribution directly by funding employment opportunities in the public, nonprofit, or social entrepreneurial sector. 

Measures and Structural Factors

Economic theory frequently assumes constant factor shares and often treats the topic as secondary. We will show that this is a mistake by deriving the first high-frequency measure of the US labor share for the whole economy. We find that the labor share has held remarkably steady indeed, but that the quasi-stability masks a sizable composition effect that is detrimental to labor. The wage component is falling fast and the stability is achieved by an increasing share of benefits and top incomes. Using NIPA and Piketty-Saez top-income data, we estimate that the US bottom 99 percent labor share has fallen 15 points since 1980. This amounts to a transfer of $1.8 trillion from labor to capital in 2012 alone and brings the US labor share to its 1920s level. The trend is similar in Europe and Japan. The decrease is even larger when the CPI is used instead of the GDP deflator in the calculation of the labor share.

The US economy has been expanding moderately since the official end of the Great Recession in 2009. The budget deficit has been steadily decreasing, inflation has remained in check, and the unemployment rate has fallen to 6.7 percent. The restrictive fiscal policy stance of the past three years has exerted a negative influence on aggregate demand and growth, which has been offset by rising domestic private demand; net exports have had only a negligible (positive) effect on growth.   As Wynne Godley noted in 1999, in the Strategic Analysis Seven Unsustainable Processes, if an economy faces sluggish net export demand and fiscal policy is restrictive, economic growth becomes dependent on the private sector’s continuing to spend in excess of its income. However, this continuous excess is not sustainable in the medium and long run. Therefore, if spending were to stop rising relative to income, without either fiscal relaxation or a sharp recovery in net exports, the impetus driving the expansion would evaporate and output could not grow fast enough to stop unemployment from rising. Moreover, because growth is so dependent on “rising private borrowing,” the real economy “is at the mercy of the stock market to an unusual extent.” As proved by the crisis of 2001 and the Great Recession of 2007–09, Godley’s analysis turned out to be correct.   Fifteen years later, the US economy appears to be going down the same road again. Postrecession, foreign demand is still weak and the government is maintaining its tight fiscal stance. Once again, the recovery predicted in the latest Congressional Budget Office report relies on excessive private sector borrowing, and once again, the recovery is at the mercy of the stock market. Given that the income distribution has worsened since the crisis—continuing a 35-year trend—the burden of indebtedness will again fall disproportionally on the middle class and the poor. In order for the CBO projections to materialize, households in the bottom 90 percent of the distribution would have to start accumulating debt again in line with the prerecession trend while the stock of debt of the top 10 percent remained at its present level. Clearly, this process is unsustainable. The United States now faces a choice between two undesirable outcomes: a prolonged period of low growth—secular stagnation—or a bubble-fueled expansion that will end with a serious financial and economic crisis. The only way out of this dilemma is a reversal of the trend toward greater income inequality.  

The American Jobs Act now before Congress relies largely on a policy of aggregate demand management, or “pump priming”: injecting demand into a frail economy in hopes of boosting growth and lowering unemployment. But this strategy, while beneficial in setting a floor beneath economic collapse, fails to produce and maintain full employment, while doing little to address income inequality. The alternative? Fiscal policy that directly targets unemployment by providing paid work to all those willing to do their part.

This paper argues for a fundamental reorientation of fiscal policy, from the current aggregate demand management model to a model that explicitly and directly targets the unemployed. Even though aggregate demand management has several important benefits in stabilizing an unstable economy, it also has a number of serious drawbacks that merit its reconsideration. The paper identifies the shortcomings that can be observed during both recessions and economic recoveries, and builds the case for a targeted demand-management approach that can deliver economic stabilization through full employment and better income distribution. This approach is consistent with Keynes’s original policy recommendations, largely neglected or forgotten by economists across the theoretical spectrum, and offers a reinterpretation of his proposal for the modern context that draws on the work of Hyman Minsky.