Fed’s Kashkari highlights reasons for tepid growth

FOMC member Neel Kashkari says post-crisis psychology is one of three fundamentals weighing on the US recovery.

Mr Kashkari believes people may be scarred after the trauma of the recession and too afraid to take on new risks. Picture: AP/Richard Drew.

Federal Reserve Bank of Minneapolis President Neel Kashkari said demographic challenges, psychological scars from the financial crisis and lacklustre technological innovation are leading causes for the tepid economic recovery in the US.

In one of his first economic papers since joining the Minneapolis Fed in January, Mr Kashkari said that, “we are likely seeing a confluence of three fundamental causes all combining to slow the economic recovery ... Unfortunately, these headwinds aren’t likely to reverse anytime soon on their own.”

The paper, released on Monday, also included a number of policy proposals but didn’t advocate for any specific actions. However, Mr Kashkari highlighted several potential solutions, such as more government spending to boost innovation, immigration reform to attract more high-skilled workers and increasing government funding on infrastructure.

Basing his paper off a June New York Times op-ed by Harvard University economist N. Gregory Mankiw, Mr Kashkari identified seven possible reasons for why the US economy hasn’t returned to its precrisis levels of growth. Noting challenges like low productivity growth and chronically low real interest rates, among others, Mr Kashkari listed a series of possible reasons for why the US economy hasn’t bounced back as much as it has since previous recessions.

Mr Kashkari said mismeasurement of GDP, a slowdown in life-changing technological innovation, secular stagnation, psychological scarring from the crisis that is keeping people from taking risks, an ageing population, policy missteps and debt overhang were possible explanations for the current economic malaise.

Mr Kashkari, who isn’t an economist by training, mostly avoided touting any specific diagnosis or policy solution. His conclusion, however, highlighted three forces he believes are fundamental to the weak recovery.

Mr Kashkari noted that recent technological innovations in social media or email aren’t as life-changing — particularly for productivity — as technological breakthroughs of the past, such as running water or electricity. “Current innovations seem to me much less likely to generate the type of future growth that we enjoyed from past innovations, “ he said.

He laid out several policy responses to the lack of innovation, such as an increase in government funding of basic research, education and immigration reform, and cutting down barriers to investment and migration.

Mr Kashkari, who was a top Treasury Department official during the financial crisis, said he also believes people may be scarred after the trauma of the recession and too afraid to take on new risks.

“Scarring affects people’s willingness to take risks: to borrow to buy a house or a car, to change jobs, to start a new business,” he said. “Scarring can last years or, some argue, even a lifetime.”

Still, he said instituting policies that can safeguard financial institutions could be one way to make people feel more confident in the system and its ability to withstand risk.

Mr Kashkari also highlighted how an ageing workforce and slowing population growth are creating demographic challenges that are contributing to weaker economic output. Immigration, which has helped beef up the workforce in the past, has slowed due to the financial crisis, he said.

Mr Kashkari said offering families more incentives for child-bearing, like tax breaks, subsidised child care or generous family leave policies, could help address the challenge. He touted immigration reform to help bring in new workers. He also suggested looking at ways to update welfare or disability insurance to correct any disincentives for work.

Mr Kashkari said he plans to explore some of the issues raised in the paper in greater depth in the future.

“It is important to understand why the recovery has been so slow if we hope to design policy responses to jump-start economic growth,” he said.

Dow Jones newswires