Lawrence Goodman on the Recovery
OpenCanada’s interview with the president of the Center for Financial Stability on the state of the global economy.
The United States is teetering on the edge of the so-called “fiscal cliff”. China is facing an economic slow-down. Debates over rescue packages amongst the members of the eurozone continue. Uncertainty has become the hallmark of the post-2008 global economy. OpenCanada sat down with Lawrence Goodman, president of the Center for Financial Stability, to hear his perspective on the state of the global economy, and the United States’ struggle to recover from the “Great Recession”.
Let’s talk about the mandate of your institution.
The Center for Financial Stability is an independent, non-partisan think-tank focused on financial markets. Our institution is multi-disciplined – with expertise in law, economics, and finance. Working on these three subjects enables us to think through financial market issues with relevance for policy.
Our staff and board members are all committed to a non-partisan and analytic approach. That is a priority for our organization because financial markets are non-partisan. A successful market is one where personal politics do not determine purely financial decisions or transactions. While politics obviously influence everything – including market behaviour – we strive to engage in sound, dispassionate analysis of financial issues.
Can you analyze for us why the U.S. economy is not recovering at a faster rate, and how going over the “fiscal cliff” might impact economic growth?
Well, that is a multipronged question. Part of the issue relates to the economic dynamics presently at play. The other part relates to the financial system and policies promulgated to repair the damage caused by this most recent “Great Recession.” On the economic front, it’s startling to think that we have experienced recession or woefully sub-par growth for more than 15 quarters. There are no signs that the U.S. economy is getting better on a sustained basis. It does seem, however, that the economy has bottomed. Whether it’s an evaluation of the housing market, or even the money data that our centre produces, you’re starting to see a bottoming out and the beginning of recovery, albeit at an extraordinarily tepid pace. We’ll be lucky if the U.S. economy grows by two per cent in 2013.
Hardly an ideal situation. What might happen to that already low growth rate if the U.S. were to venture over the fiscal cliff?
The fiscal cliff is a thoroughly man-made problem. It is the expiration of one-time benefits that essentially kicked the can down the road. We are now at the end of the road. My perspective is that we will ultimately get an agreement that prevents us from going over the fiscal cliff, albeit one that is extraordinarily watered down in terms of how it addresses the underlying economic fundamentals. And yet, while we’re unlikely to fall over into that steep divide, the fiscal cliff should really be used – as I have said elsewhere – as a fiscal opportunity. The financial position in the United States is highly compromised, and the fiscal cliff itself – especially with all the attention it’s getting – should be used as an opportunity to get our house in order.
The Canadian government in the 1990s did not like the fact that the debt was increasing at a rapid rate, and had to make some very tough decisions. Canada shifted to adopt strict policies that were sustained over several administrations. The strong actions undertaken in that decade have kept Canada in good shape. I am hopeful that the U.S. fiscal cliff will trigger a similar redirection of policy. This is our opportunity to begin to whittle down our deficits over a long and extended period of time.
Another one of the issues – the “other fiscal problem,” so to speak – is that there is a wall of principal payments falling due on Treasury debt. The U.S. Treasury has been funding debt on the short end of the curve, and that creates a burden on financial markets. I think that if the attention being showered on the fiscal cliff was also channelled towards this issue, we could make significant progress.
Can you speak to what we might expect from the new Obama-led administration in terms of addressing these issues? What steps might be taken during the first 100 days?
Well, the authorities have been pretty clear about what they want to see – for example, increased tax rates for higher-income groups. The new administration is likely to extend the alternative minimum tax fix and continue to pursue ways to deepen the revenue base. It’s questionable, though, whether the authorities are going to aggressively attack the contingent liabilities that come from Social Security, Medicare, and Medicaid. We speak a lot about uncertainty in the American economy. A big part of that uncertainty has to do with paying for these contingent liabilities, because payments are going to need to be made in the not too distant future. The first 100 days are really an opportune time to address and attack some of these obstacles to sustained progress.
I’m hopeful that there will be an agreement to address the structural impediments that exist in public finances in the U.S. today. I think this is one of the most important issues for the country over the long term. If deficits can be reduced to the point of being far below the nominal GDP growth rate, we will have reached an important economic milestone, and one that takes some of the pressure off the Federal Reserve that is trying in its own way to move the economy forward.
What is your take on China’s growth trajectory and the importance of that to recovery in the United States? Will competition from China undermine a full U.S. economic recovery?
China is extremely important for the United States, whether in reference to the composition of its growth or economic policies. China as an engine of economic activity is undoubtedly important for the U.S. and the world. So how China acts on the world stage and how it chooses to manage its economy over the next five to 10 years is extraordinarily important. It is critical for China to transition from being export-led to being more domestic-oriented, building a consumption base – its composition of growth really matters at the regional and global levels.
In terms of China’s importance to the U.S. recovery, the U.S. is still an extraordinarily large economy and a meaningful growth driver for the rest of the world. This is not likely to change dramatically in the near future. So, our own monetary-fiscal policy mix going forward will be crucial. To be sure, China’s trajectory will influence U.S. growth, but the U.S. still has an ability to grow in an independent fashion, providing support for the rest of the world, as does China. The global economy is composed of multiple overlapping and interconnected economic spheres. We want to be firing on as many cylinders, across as many spheres, as possible.
On the U.S. as an engine for growth, what do you make of the argument that innovation in the U.S. may be stagnating because all of the easily accessible, game-changing innovations have been made? Do you think encouraging innovation is a matter for public policy?
That is a great question. I think innovation can be created at any time, in any place. It is the government’s role to ensure that individuals and business entities have the ability, in as unencumbered a fashion, to be creative, and to be innovative. It is nearly impossible for us to speculate as to what the next innovation will be. I would posit that there are enough forces in the world today that the potential for innovation is as great as it has ever been.
Government policy needs to be supportive of entities venturing into the unknown. So we may need patent reform and business-friendly policies that aren’t in play now. I think that the key issue for public policy is to create as harmonious an environment as possible for people to build new industries, whether it’s in Silicon Valley or Waterloo in Canada.
To the degree that the U.S. economy provides unparalleled opportunities, America will continue to be a leader in innovation. The government can create an environment where there’s long-term growth and low inflation without major imbalances. That’s the perfect cocktail for innovation. I’m hopeful that we will see policies that are hospitable to further innovation.
Looking ahead to the next four years, what changes in policy would you ideally like to see?
I would like to see distortions reduced. Our budget deficits in the U.S. are running between seven and 10 per cent of GDP per annum. The cumulative budget gap between spending and revenues has been 40 per cent of the GDP over the last five years. This is the largest fiscal expansion in the last century – larger than what happened in the 1980s. It’s also larger than what happened in the 1930s, where we saw a deeper dive in the economy and the implementation of the New Deal.
The government in the U.S. has been extremely active at priming the pump. We need to remove the distortions that have flowed from that, and we need to move smoothly and steadily towards lowering the deficit. We also need to rework our amortization profile – how we fund the deficit and U.S. debt. On the monetary front, the Federal Reserve has increased, on average, total reserves by 110 per cent per annum since 2008 – that’s a large increase in money creation. In the broader financial system, however, there has not been a sympathetic response. It would be beneficial to see this distortion in monetary policy evaporate over the next four years.
The policy mix used to stimulate and safeguard the economy was put together in a hasty fashion. Dodd-Frank is 2,300 pages long, and in many parts it’s indecipherable. A simpler regulatory effort will help. We certainly need regulation, but we need regulation that incentivizes investors, corporations, and individuals to do the right thing. Those are some of the policy shifts that I would like to see over the next four years.
This interview was edited for length and clarity