Tyler Cowen says there are three ways that declines in consumer demand can make itself felt, but I'm just going to focus on the first two:
- A general decline in spending.
- A disproportionate and permanent demand decline for the more income- and wealth-elastic goods, a category which includes many consumer durables and also luxury goods.
The first, he says, can be addressed via stimulus. The second can't. For what it's worth, this is a distinction that's been eating at me for a long time too. One of the things that was clear after the housing bust and the financial collapse of 2008 was that Americans were simply consuming too much. Relative to the rest of the world consumption needed to go down, but in the short term this would be so economically disastrous that we couldn't allow it to happen right away. The Wall Street bailout and the stimulus bill really were necessary.
But our current account deficit, after shrinking a bit in 2009, has started to grow again, and in the long term we can't keep this up. International trade and money flows have to start balancing out eventually, and that means less consumption from the U.S. and more from countries like China.
This has been the contradiction at the heart of fiscal and monetary policy for the past two year. Do we damn the torpedoes and stimulate now, simultaneously swearing on a stack of Bibles that we'll restrain ourselves after we've gotten back on our feet? Or should we gulp hard, work through the pain all at once, and get our economy back on a sustainable track now? Back in 2008, I remember concluding that the trend level of consumption in the U.S. needed to drop 5-10% at some point, and obviously that hasn't happened yet. What's more, even if we wanted to make it happen we're constrained by the policies of export-oriented economies like China's, which have to take the other side of the deal and increase their consumption considerably. That hasn't happened either.
So I still don't know how this all ends. Trying to adjust to a big drop in the trend level of consumption seems suicidal at the moment, and for that reason further stimulus seems like a good idea. But even while acknowledging that, I still wonder when and how we're going to get ourselves back to a sustainable level of economic activity. I don't think the answers are any easier today than they were two years ago.