News at Smith

Three Culprits for Slow Economy

Jun 02, 2015

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SMITH BRAIN TRUST -- Not reaping the expected benefit of cheap oil, the U.S. economy shrank at an annualized pace of 0.7 percent in the first three months of this year. “When data do not fit expectations, the knee-jerk reaction is to look for excuses,” says Bill Longbrake, executive in residence at the University of Maryland's Robert H. Smith School of Business Center for Financial Policy. “Was it bad weather, the West coast dock strike, faulty seasonal adjustment methodology, the strong dollar, consumer reluctance to spend potentially temporary gas expense savings or something else?”

On page one of his May 2015 Longbrake Letter, he outlines a rippling effect of three culprits behind “the emerging long-run trend of slower growth” in the economy: 1. Secular stagnation tends to play out in mature economies when low interest rates reflect "saving trumping investing;" 2. The subsequent lack of public and private investment spending also is driven by the political agenda and uncertainty; and 3. The uncertainty, or change in expectations about the future, can be self-fulfilling. For example, an expectation of low or declining inflation may be interfering with the tendency of wages to rise when the labor market tightens.

“Employers lack pricing power and resist wage increases,” Longbrake says. “Employees become less demanding for increases in nominal wages because they are less concerned about losing inflation-adjusted spending power.” Longbrake lays out the domino effect:

  • Low real interest rates crowd out low-return, riskier investments.
  • Productivity slows because of diminished investment activity.
  • Real economic activity grows more slowly. 
  • Incomes rise less rapidly along with slower economic growth and this depresses growth in consumption.
  • A persistent output gap is highly deflationary. 
  • The excess between desired saving and desired investment goes into speculation and drives price bubbles in financial and real assets.
  • Asset price speculation benefits the rich; low productivity penalizes the poor by holding down wage increases, and collectively both phenomena drive increasing income and wealth inequality.

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About the University of Maryland's Robert H. Smith School of Business

The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and part-time MBA, executive MBA, online MBA, specialty master's, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.