COVER STORY • 3Interview with Dr. Joseph Gagnon, Senior Fellow at the Peterson Institute for International
Economics in Washington D.C.

S

trong US Economy Could Turn Global
Economic Outlook Positive as the Delta
Virus Variant Increases Uncertainty

By Japan SPOTLIGHT
Whether the US economy, the largest in the world, is on course for a stable recovery from the pandemichit economic decline in 2020 will be a key to the prospects for global economic health. We interviewed Dr.
Joseph Gagnon, senior fellow at the Peterson Institute for International Economics, a US think tank. He isa distinguished academic who has also worked as a policy maker for the US Treasury Department and theFederal Reserve Board. He is thus a leading thinker on US fiscal and monetary policy.
(Interviewed on July 27, 2021)

Concerns About Inflationin the United Statesmonetary policy causes the dollar todepreciate and that is inflationary – I don’t
think that scenario is ever going to happen. I
JS: There are growing concerns
see two possible outcomes: one is what theover inflation in the US, due to an
market expects, that we don’t get much
expansionary monetary and fiscal
inflation and monetary policy stays loose andpolicy continuing during thethe dollar stays where it is, providing normal
pandemic. This policy could
growth and normal inflation and very little
weaken the dollar and provokechange in the exchange rate. I think the
inflation. Do you think that is amarkets expect that. The other risk which I
relevant concern? Does this differ
think is more likely, but the market does notdepending on the short or long
believe as much, is that the economy is muchterm? And how do you see thestronger, and growth is much faster thanissue of propping up zombie
people expect. Employment growth is faster,companies through public policy?
the unemployment rate falls very far to
around 3% and perhaps even lower. This
Gagnon: The concern about zombie
means that the inflation we see this year turns
Dr. Joseph Gagnon
companies everywhere, especially in Japan, isout to continue into next year. In that case,a huge mistake. Zombie companies are good for the economy as
the Federal Reserve (Fed) is going to have to tighten more than thelong as the economy is operating below potential and as long as
market expects, and the dollar will rise more than the market
inflation is below the central bank’s target. More zombie companies
expects. We won’t know till maybe March or June of next year.
are better than fewer because if you put them out of business you
During the rest of this year it is going to be very difficult to gauge
just make the deflationary pressures worse, with more people
underlying inflationary pressures. You are going to see some prices
unemployed and less aggregate demand making the whole economy
falling – car prices will be falling so negative inflation in those prices,
worse. So it is a complete mistake to worry about zombie companies
but other prices will be rising such as rents and it will be hard to
until the inflation rate is well and persistently above the central
disentangle the overall message on inflation for the rest of this year.
bank’s target. Only then are they a problem, and only then do they
Next year is when all those temporary factors will be gone, and thenreduce productivity growth. So I think this worry about zombie
we will have a sense of where the economy is heading.
companies is very harmful, has caused a lot of damage in Japan andis causing a lot of damage elsewhere and should be stopped
Prospect for the US Economy in 2022
immediately. It will be many years before any country has to worry
JS: At this moment, the 2021 US GDP growth rate isabout zombie companies; in the meantime, they are very beneficial.
predicted to be around 6-7% according to theTurning to inflation, you mentioned a scenario under which loose
https://www.jef.or.jp/journal/

Japan SPOTLIGHT • November / December 2021

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majority of economists, and the unemployment ratearound 3-4%. Are these accurate estimates for 2021?
And would this economic performance continue into
2022?
Gagnon: My own forecast is a lower unemployment rate – below 4%
and by some point next year closer to 3%. Instead of 6% growth I
might see 7% or 8% growth.
JS: Would this economic performance likely continue

into 2022?

Gagnon: Yes, because the fiscal stimulus that we just got actually
has a little bit of its spending into next year, and probably we will get
this infrastructure and other packages in the next couple of months,
so there will continue to be forces upholding the economy next year.
Growth won’t be 6% or 8% next year but it will be at least 2%,
probably 3% or 4%.
JS: So that means the dollar would be strengthened

as a result of this strong growth?

Gagnon: My view is that the dollar will go up but probably not till
next year.

Direction of US Monetary Policy in the
FutureJS: Looking at the economy in the long run, youmentioned that at this moment expansionary
monetary policy shouldn’t be a problem in terms of
the efficiency of the economy. But in the long runmonetary policy will be tightened – is that right?

Gagnon: My best guess is that the Fed will have to start raisinginterest rates at some point, not this year but maybe next year, but I
don’t think we are going to see very high interest rates. All of thisfiscal policy might be raising the interest rate a percentage point orso, so it’s not a huge thing but it is noticeable. You might see interest
rates in the US 100 or 200 basis points higher for a couple of years
than currently projected.
JS: We agree with you regarding economics, but interms of politics would it be possible to raise interest
rates?

Gagnon: Not a problem. Interest rates are very low, and a lot of
14 Japan SPOTLIGHT • November / December 2021

people would like them to go up, and unless they get up to 5-10%(which is not going to happen) then there is no worry. As long as the
economy is strong, I think that US President Joe Biden in particularwould rather have interest rates higher by 1 or 2 percentage points
than a much higher inflation rate.
JS: In the US there are some serious politicalquestions regarding the income gap. Poor people
may have a different view on the interest rate hike.

Gagnon: I don’t think so – first, poor people don’t earn or pay any
interest, so they don’t care. (Some poor people take out credit cardor payday loans at very high interest rates, but those rates are notmuch affected by Fed policy.) People slightly above the bottom mayborrow to buy a car or a house and they would appreciate lowinterest rates but it’s not a big deal for them. The big thing for thepeople at the bottom of income distribution is jobs. If theunemployment rate goes below 4% significantly, those people will
have very strong increases in their wages, and we have seen thatmany times. That is far more important than any small hike ofinterest rates. It’s not an issue.

Job Security
JS: Job security is a very important goal for economic

policy. In your view, is US macro policy working wellto achieve this goal?

Gagnon: If you listen to Fed Chairman Jerome Powell, for two years
now he has been talking about the benefits of a “high pressure
economy”. He wants full employment everywhere and he talks about
how this has disproportionate benefits for the people at the bottomof the income distribution, the low-wage workers. They were getting
big gains when the unemployment rate was 3.5% two or three years
ago. I think they are starting to get them again, coming out of thepandemic, and he is very happy with that. I hope to write a paper on
this in the fall. In my view, every advanced economy – starting withJapan in the early 1990s and spreading to Europe and North America
in the late 1990s – has been operating below potential pretty muchcontinuously. I do not believe the estimates put out by the IMF, theOECD, the Bank of Japan and the Fed of potential output gaps andunemployment gaps; they are all wrong. The closest one to being
correct is the one by the US Congressional Budget Office which has
a good estimate of the natural rate of unemployment, but even they
are too pessimistic. The natural rate of unemployment is even lower,
so potential output is even higher than they think. Inflation is very
resistant to going below zero and where that resistance happens is alittle different in Japan, the US and Europe. In Japan, the floor isaround zero while in the US and Europe it is about 1% inflation.
Getting below that floor is very hard to do. You can have a lot ofexcess unemployment, output can be below potential for many,
many years without causing further declines in inflation, because it
stops at that bound or limit of no inflation. Central banks havemisunderstood where potential is because they didn’t see that boundon inflation and so all advanced economies – starting with Japan –have had major macro policy errors for decades. I think Powell is thefirst central bank governor to understand this correctly.
JS: Consumption growth in the post-pandemic era

could be key to achieving robust economic growth.
All countries are worrying about consumption growth
and working hard to restore it. In the US wages havestagnated in recent years, but do you think wages
need to be raised to restore consumption?

Gagnon: I would support an increase in the minimum wage in theUS, but I don’t think that’s the most important thing; frankly, theminimum wage is technically $7 an hour but you can’t hire anybody
for less than $12 or $15 dollars an hour these days. It should beraised to $12 or even $15 per hour in major urban areas. We haveseen very strong wage growth at the low level over the past few
years. Before that there was stagnant wage growth for a long time,and I think there are two reasons for this.
One is that the US economy was operating below potential for
most of the past 20 years and when you are below potential, thepeople who are hurt the most are the people at the bottom, just as
when you are above potential the people who are helped the mostare those at the bottom. We have been below potential which hurts
those at the bottom disproportionately. We will be back above
potential next year and that will help the bottom. The other factor has
to do with competition. Several studies have found that the US
economy has gotten less competitive in terms of markets andcompetition within markets. The number of companies in eachmarket is smaller now, there are fewer companies with more market
power earning excess profits that go to the management andshareholders but not the workers, and that has increased as a shareof the economy which means that the wages at the bottom haven’t
kept up with overall GDP growth because some of the GDP growth
was just going to the owners and the management. That has been aprocess that has been going on for 30 years or more, so I think thatthe Biden administration sees that and wants to reverse it. If you
raise taxes on companies and rich people and increase benefits topoor people with childcare and healthcare and so on, you can help
offset that and that is what the government is trying to do here. I

don’t know if that is happening in Japan, if Japanese markets areless competitive and the profits are going to just a few people. If you
look at the OECD studies on how efficient and competitive markets
were, the US was always ranked highly. Japan was a kind of dual
economy where the goods industries were very competitive, but theservices industries were very uncompetitive. Now you have more
efficient retailers and other service distribution changes in the past
30 years so maybe you have caught up, while the US has becomeless competitive. The OECD used to say that the US was much morecompetitive than Japan, especially in services, and maybe that haschanged.
JS: You mentioned the US economic growth potential,

but what would happen to that potential due to thepandemic? Would it have a negative impact on it?

Gagnon: I don’t fear big effects but there are two smaller effects thatare offsetting. More people are retiring. They lost their jobs, thestock market has done well, their housing has done very well; sothey are wealthier than they expected and don’t want to go back towork. On the other hand, you see a lot of businesses trying new
ideas and technologies during the pandemic and those are increasing
productivity and may remain. There is a mix of less labor growth
going forward and maybe more technology growth. I don’t see a big
net effect on the central growth rate, but it is good news because itmeans more output per worker. I see the US potential growth rate as
something close to 2%.
JS: On the question of wage hikes, somebody

mentioned that the reason why the US wage increase
rate is low is due to the weakening power of labor
unions – would you concur?

Gagnon: It might be true, it could be part of the less competitive
conditions, but I think that is looking backward to the past 20 years.
In the past two years that has all changed, and there is a big change
at the bottom of the labor distribution.

US Debt Management Policy
JS: Moving to the question of debt, US Congress

members are very concerned about the stability of
government debt. Once interest rates rise as the
economy gets on a recovery path, the debt might
possibly rise with growing interest payments. How
can US policymakers manage this question in thelong run?
Japan SPOTLIGHT • November / December 2021

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Gagnon: I don’t worry about it too much. You can’t borrow forever,but I think that the amount governments can borrow has increased
as interest rates have come down globally. This phenomenon is not
limited to Japan or the US, and the biggest single factor is low birthrates. Lower birth rates mean lower growth rates, which mean lower
interest rates. The other factor is longer life spans. Longer life spans
are a harder thing to judge because they might first lower and thenraise interest rates, but the net effect so far has been to lower
interest rates – it might change. Some people think that the nature oftechnology has changed, as pointed out by Larry Summers. If you
look at General Motors and Google – which are two very different
companies – they both have about the same amount of sales interms of revenue, but General Motors has about 10 times as muchcapital stock – all the factories and equipment and dealerships
around the world. It takes far more investment to generate thatrevenue for a company like General Motors; whereas for Google
there is very little investment, basically just some buildings andcomputers in them.
The amount of investment you need to generate growth is lessthan it used to be and that holds the interest rate down because thereis less need to borrow. That has been holding interest rates down.
Some countries have big savings rates and have been exportingthem to the rest of the world by government policy that buys up
foreign assets. All the oil revenue money that used to be spent is
now saved, and that pushes interest rates down. All these factors
have combined to push interest rates down and this looks likely tocontinue for a long time. There is one study by Charles Goodhart andManoj Pradhan that claims that it is going to turn around soon but
they are only looking at one of several factors and that is too
simplistic. The new thing since their book is the change in US fiscal
policy, and that will tend to push up interest rates. Even with all thefiscal stimulus that the US has had and is likely to have, mostestimates are that it will only raise US interest rates by maybe 1% in
the long run. So it’s not completely going to reverse what we haveseen, and some people say less than 1%. So somewhere between
0.5% and 1%. It is not going to push interest rates permanently backto where they used to be (interest rates may rise more than 1%
temporarily as the Fed responds to temporarily higher inflation).
But your question would be, yes, but what if the economy is sostrong that the Fed must raise interest rates even more to keep
inflation in check? Well, that would be a surprise but would be in thecontext of a very strong economy and we would have time togradually adjust. The US government, although divided, will
eventually adapt and it doesn’t have to be within a year or two – they
have several years to adapt. It would almost certainly be in thecontext of strong economic growth which would make it easier to dothat. If we don’t get strong economic growth, then interest rates are
16 Japan SPOTLIGHT • November / December 2021

not going to go up.
JS: Apart from the question of interest rates, a budget

must be prepared for so many challenges. In the caseof Japan in particular, preparations for an aging
society will require major social expenditure. In thatsense, older countries including the US and Japan
are in a difficult position because due to thepandemic they must increase government
expenditure for restoring infrastructure. In the future,
there may be some new demands on the fiscal
budget. How can we prepare for such additional
expenditure? Some are recommending a kind of“Tobin Tax” globally overall. Would this be a goodidea in your view?

Gagnon: First, too many people are too worried about fiscal policy. In
Japan people have been worried about fiscal policy for a long time,and it’s been a mistake. Fiscal policy has never caused Japanproblems. The way to judge whether fiscal policy is a problem is tolook at longest-term interest rates in real terms corrected byinflation, and they are very low in Japan. That means that the market
is not worried, even 30 years down the road, which is also true in the
US. In its latest budget, the White House showed the true cost of the
US national debt in terms of real interest rates, and the debt is anegative burden on the US. We actually earn money by borrowing
rather than it costing money. I bet the same is true in Japan and if it
is not, it is because you have not created enough inflation.
Secondly, the best way to deal with fiscal policy in Japan is to get
more inflation. I am convinced that if Japan could raise its inflation
rate by 2 or 3 percentage points to 3% or more, interest rates will
not rise by that much in the long run. Therefore, you will reduce theburden on the government because interest rates will be below thegrowth rate of the economy and below tax revenues. The best tax is
an inflation tax: Japan needs an inflation tax and that would be thebest solution in my view.

The Digital Economy in the US
JS: The digital economy is progressing significantly

during the pandemic. This could be helpful in raisingproductivity.

Gagnon: I tend to think that the private digital currencies like Bitcoinand so on are just a Ponzi scheme, mere bubbles. Regulators should
clamp down hard on them and I don’t think they serve any useful
purpose. I don’t think they are going to be transformative and arerather like gambling. Some people will make money, some people
will lose, but it is a waste for the economy – rather like having agambling casino. People need to understand that these things arefundamentally useless except for criminals.
JS: How about digitization in general, as a force forpushing up productivity and producing jobs?

Gagnon: Maybe – I worry that there is also cost. The criminals andransomware attacks and cyber-attacks are a concern. I don’t have agood sense as to how much of a cost there is. Productivity growth
was strong in the pandemic, but that was partly just because the typeof people who lost their jobs tended to be lower productivity
workers. There are all kinds of issues going on – issues relating to
how businesses operate; restaurants are doing more takeout andautomating their ordering systems, but I am not sure how importantthese issues are.

US Macro Policy’s Global Impact
JS: The possibility of the rise of interest rates in the

US may cause problems in developing countries due
to capital flight. Do you think a US interest rate rise
will be moderate, so that will not happen?

Gagnon: The US interest rate rise will likely be moderate so there
could be some of that, as well as some offsetting benefits. One of myconcerns is the extent to which people in other countries borrow indollars, which is very risky. If US interest rates rise and you haveborrowed in dollars, you will be hurt. I don’t know why governmentsallow this, but it is not really a concern of the US. We don’t
encourage foreign countries to use the dollar so much that theyborrow in it; every country should borrow in its own currency andneeds a good monetary and fiscal framework to do that. We’ve seen
big progress in so many countries like South Korea and throughout
Asia, such as Thailand – they can borrow in their own currency. The
same is true in many Latin American and African countries, but there
are also still many that continue to borrow in dollars. If you didn’t
borrow in dollars, then your central bank has the freedom to moveinterest rates separately. Obviously if the dollar rises because ofstrong US interest rates, that may be a reason to raise interest rates
in foreign countries to keep their own currencies from falling too
much, to be too inflationary. It would be in the context of strong US
growth which would buy a lot of imports; I think the US trade deficit
is going to get bigger, and that will help exports from other countries
and help offset the costs. So I think you will see some rotation awayfrom consumption and investment into exports in these countries,

and they should be able to handle it. Many countries are poorly run
and will make mistakes and blame the US as they always do. No one
is forcing them to make these mistakes. We all must respond to eachother; we are all interdependent and shouldn’t blame each other for
problems.

Conclusion – US Economy & Macro Policies
Are on the Right Track
JS: Judging from your answers today, you believe that

US economic growth is achieving an ideal economic
recovery, not only in light of the US domestic
economy but also the global economy. Is thiscorrect?

Gagnon: Yes. I believe that the US is going to have a strong recovery
and both monetary and fiscal policy have been excellent. I have beenamazed at how strong the fiscal response has been, and I think weare going to have a stronger year than the forecasts even. A lot of
forecasters in the Fed are still worried about the effects of thepandemic, and looking at Japan where vaccination rates are low, I
can sympathize, as this is not good for the economy. This is a worry
and reduces demand for US exports and is thus a drag on the US
economy. But in terms of the US, Canada, and Europe where
vaccination rates are high, we are going to have a very strong
recovery because even with the uptick in cases in the US, 99% of
people who are not vaccinated are people who have chosen not to be
vaccinated because they are not afraid of the virus. So they are notgoing to stop going out, shopping, working and spending money.
And those that are vaccinated are probably not going to stop either
so even with cases rising in America, I don’t see an economic
slowdown, I see strong growth. (Recent news that vaccines are lesseffective in preventing mild infections from the Delta variant
compared to previous variants does raise some concern. But theeffectiveness remains strong in terms of severe illness and death, so
any economic effect should be mild.) I think forecasters in the US are
too cautious about the pandemic. I think that the fiscal stimulus is sostrong that it will offset any slow growth and slump in US exports.
We haven’t seen two years in a row with this much deficit spending
since 1943; it is just enormous.

Written with the cooperation of Joel Challender who is a translator, interpreter,
researcher and writer specializing in Japanese disaster preparedness.

Japan SPOTLIGHT • November / December 2021

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