While rubbing elbows with the global elite at the World Economic Forum in Davis, Switzerland, on Wednesday, economist Nouriel Roubini laid out why inequality issues are affecting U.S. economic growth and why global economic issues require bolder action.

The New York University professor says the issue of economic inequality, a focus of President Barack Obama’s State of the Union speech on Tuesday, matters for a variety of reasons, not the least of which is that it is becoming more severe.  

“Inequality is worsening in many advanced economies and especially the U.S.,” he said in an interview on Bloomberg TV. “You have to ask yourself ‘why?’ ”

The economist, who served in the Clinton administration, points to the capital-intensive and labor-saving nature of technological innovation. He also says that trade and globalization reduce the income of workers with low skills or partial skills.

While rising inequality leads to socopolitical instability, “It also has negative effects on economic growth by redistributing income from those who spend more to those who save more,” Roubini explained. “Over time, the fall in the share labor income is going to have a negative impact on economic growth and aggregate demand.”

President Obama addressed these downsides “correctly,” the economist says. “We should tax slightly more the top 1 percent and financial institutions.”

Though he doesn’t see Republicans in Congress supporting such policies, Roubini advises the party to consider its base. “Even among Republicans, it’s the middle and lower class who votes for them, and they are concerned about inequality.”

A change of heart within the GOP could help. In the 2012 presidential race, “[Mitt] Romney lost in part, because he made remarks about the 47 percent” who rely on some government support, he said. “If that is the GOP attitude, it’s not going to be good for them in 2016.”

Global conundrum

Asked about what advice he would give Federal Reserve Chairwoman Janet Yellen and other central bankers in confronting the risk of deflation, the economist spelled out the difficulty of addressing today’s complex issues.

“It is not in the books, because six years after the crisis we have tried zero policy rates; we have done quantitative easing, credit easing, forward guidance; we have done negative deposit and interest rates in nominal terms; we have done … foreign-exchange intervention,” he stated. “Now, last week in Switzerland, the 10-year Treasury yields were negative. Which kind of a world is this?”

The gold bugs were incorrect by saying that Fed policies would lead to the collapse of the U.S. dollar and hyperinflation. “They got it all wrong,” Roubini said. “Gold is down, the dollar is up, and we have a problem with a lack of inflation — of deflation.

In spite of monetary stimulation, he adds, “There is not enough fiscal stimulation, and therefore output is still below trend.”

What’s needed — in addition to a focus on deflation — “is not just the right monetary policy,” he says.

Quantitative easing worked in the U.S., Roubini explains, “because you had back-loaded fiscal consolidation, while [fiscal consolidation has] been frontloaded in the case of the eurozone. Structural reform has to occur in Japan, the eurozone and even the U.S. You have done a combination of policy [moves] and have not done the right thing.”

The economist still sees the Fed raising rates this year. What would stop such a move?

“If the rest of the world surprises on the downside and if the dollar sharply appreciates further, at some point, the U.S. is not going to be able to decouple from what is happening in rest of the world,” he said.

“Economic growth could slow down, we could go into deflation, and they could postpone the start of the hike — or they could start the hike and then reverse themselves, or in a very extreme scenario they could go back to quantitative easing.”

In other words, the more things change, the more they stay the same — even at Davos. 

See also:

Mester says Fed may raise rates within the next six months

Expect low interest rates, moderate GDP growth & yields in 2015