Returning to the "Old Normal"
In "Can America Grow Again?" (WSJ May 30, 2018), the four contributors to the debate missed perhaps the most important contributor to the decline in US GDP growth after the Great Recession: The risk-free interest rate dropped to zero and stayed there for nine years. Because M3 is $20 trillion, risk-free interest rates of 5% on deposits, checking accounts, and money-market funds had provided Americans with $1 trillion per year of discretionary income before 2008, representing 5% of annual GDP. In 2009, this rate fell to zero, contributing to the 8% decline in GDP that year. As that risk-free rate now recovers, each 100 basis points of increase in the rate contributes to 100 basis points of GDP growth, GDP and M3 being roughly equal. Consequently, a gradual recovery in rates back to 5% by 2023 could boost GDP growth from 2% per year to 3% per year for the next five years. And remember, interest rates are a function of demand for money, which can increase even if inflation does not. Strong growth created by capital investment resulting from the reduction in the corporate income tax rate is likely to drive real rates, and consequently GDP growth, back up to the old normal.