On secular stagnation

December 16, 2013

Some time ago speaking at the IMF, I joined others who have invoked the old idea of secular stagnation and raised the possibility that the American and global economies could not rely on normal market mechanisms to assure full employment and strong growth without sustained unconventional policy support. My concern rested on a number of considerations. First, even though financial repair had largely taken place four years ago, recovery since that time has only kept up with population growth and normal productivity growth in the United States, and has been worse elsewhere in the industrial world. Second, manifestly unsustainable bubbles and loosening of credit standards during the middle of the last decade, along with very easy money, were sufficient to drive only moderate economic growth. Third, short-term interest rates are severely constrained by zero lower bound and there is very little scope for further reductions in either term premia or credit spreads, and so real interest rates may not be able to fall far enough to spur enough investment to lead to full employment. Fourth, in such a situation falling wages and prices or inflation at slower-than-expected rates is likely to worsen economic performance by encouraging consumers and investors to delay spending, and to redistribute income and wealth from higher spending debtors to lower spending creditors.

The implication of these considerations is that the presumption that runs through most policy discussion — that normal economic and policy conditions will return at some point — cannot be maintained. The point is demonstrated by the Japanese experience, where gross domestic product today is less than two-thirds of what most observers predicted a generation ago, even as interest rates have been at zero for many years. It bears emphasis that Japanese GDP disappointed less in the five years after the bubbles burst at the end of the 1980s than the United States has since 2008. GDP today in the United States is more than 10 percent below what was predicted before the financial crisis.

If secular stagnation concerns are relevant to our current economic situation, there are obviously profound policy implications that I will address in a subsequent column. Before turning to policy, though, there are two central issues regarding the secular stagnation thesis that have to be addressed.

Is not a growth acceleration in the works in the U.S. and beyond? There are certainly grounds for optimism, including the recent flow of statistics, strong stock markets, and the end at last of sharp fiscal contraction. Fears of secular stagnation were widespread at the end of World War Two and proved utterly false, and today secular stagnation should be viewed as a contingency to be insured against, not a fate to which we are consigned. Yet, it should be recalled that the achievement of escape velocity has been around the corner in consensus forecasts for several years now and we have seen, as Japan did in the 1990s, several false dawns. More fundamentally, even if the economy accelerates next year, this provides no assurance that it is capable of sustained growth along with normal real interest rates. Europe and Japan are forecast to have growth at levels well below the United States. Throughout the industrial world, inflation is below target levels and shows no signs of accelerating, suggesting a chronic demand shortfall.

Why should not the economy return to normal after the effects of the financial crisis are worked off? Is there a basis for believing that equilibrium real interest rates have declined? There are many a priori reasons why the level of spending at any given level of safe short-term interest rates is likely to have declined. These include (i) reduced investment demand, due to slower labor force growth and perhaps slower productivity growth; (ii) reduced consumption demand, due to a sharp increase in the share of income held by the very wealthy and the rising share of income accruing to capital; (iii) on a global basis increased savings and increased risk aversion, as governments accumulate trillions in liquid reserves; (iv) the continuing effects of the financial crisis, including greater costs of financial intermediation, higher risk aversion, and continuing debt overhangs; (v) continuing declines in the cost of durable goods, especially those associated with information technology, meaning that the same level of saving purchases more capital every year; and (vi) the observation that any given real interest rate translates into a higher after tax real interest rate than it did when inflation rates were higher. Logic is supported by evidence. For many years now indexed bond yields have trended downwards. Indeed, U.S. real rates are substantially negative at a five-year horizon.

Some have suggested that a belief in secular stagnation implies the desirability of bubbles to support demand. This idea confuses prediction with recommendation. It is of course far better to support demand by supporting productive investment or highly valued consumption than by artificially inflating bubbles. On the other hand, it is only rational to recognize that low interest rates raise asset values and drive investors to take greater risks, making bubbles more likely. The risk of financial instability provides yet another reason why preempting structural stagnation is so profoundly important.




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Well finally Mr. Summers is waking up to the fact that the world changed. I’m actually looking forward to his next article now. I think he is influential enough in the economics world to actually start a trend. Unfortunately he has yet to see that the USA has been replaced or at least diminished by the new USCA. When that finally sinks in we may actually see him support policies that will help the average American citizen.

Posted by tmc | Report as abusive

Aggregate consumer demand is the only question that should be addressed and to do so properly will necessitate raising the question of declining real wages.If the USA does not deal with this issue for ideological reasons, then it will have to wait for the Chinese consumer to pull it out of the rut, and that will take years.

Posted by Biscayne | Report as abusive

Tens of millions have systematically/permanently lost living wage jobs.

Young adults (often with student loan debt) see American Dreams they cannot earn yet this group is now well aware a job requires them to pay into Social Security, Medicare and now Healthcare for others.

Boomers are maybe now focused on inheritances rather than spending as they realize Global has extinguished The Land of Opportunity.

Only a fool would believe Tomorrow will resemble Yesterday.

Posted by SaveRMiddle | Report as abusive

This piece seems to be a continuation of Mr. Summers’ recent comment, “Suppose then that the short term real interest rate that was consistent with full employment had fallen to negative two or negative three percent….” The idea that it would take negative interest to achieve full unemployment, combined with the comparison to Japan during the 1990s, suggests that what we are succeeding in doing today is fighting off deflation — but not much else.

Posted by Bob9999 | Report as abusive

It is not real employment if not dictated by “normal market mechanisms”, and it is not real growth if driven by “unconventional policy support”.

Posted by abnewallo | Report as abusive

Interest rates are always a zero sum game. Even foreign interest earned or paid equalizes via supply and demand in currency rate changes. So fiddling with rates up or down is unlikely to ever do much more than steal from Peter to pay Paul. Real changes could include constitutionally limiting fractional lending, allowing states full control over immigration and labour laws, death taxes approaching 100% for amounts over 5 million.

Posted by BidnisMan | Report as abusive

Sustained unconventional policy is not sustainable –

The demand side in Western economies is weak for a reason, and it’s one that takes decades to deal with: changed demographics and lost competitiveness. These two mega trends lead to lower wages and a reduced propensity to consume goods and services.

Over stimulating demand by cheap credit and by consumption beyond what households could afford proved to be devastating, and over stimulation by the brute force of the Fed’s printing press doesn’t work, and we’re beginning to see how severe its side effects are.

Posted by reality-again | Report as abusive

I will better wait for part#2 before making any comment.
However, it really a big breakthrough that MSM sources can assume now that we might living in the changed economy. And the cherished cycles’ theory (the whole economic science) may not applicable any longer.

Posted by OUTPOST2012.NET | Report as abusive

“the American and global economies could not rely on normal market mechanisms to assure full employment and strong growth without sustained unconventional policy support”

Larry and the Rubin gang still does not get it. “Normal market mechanisms” worked like this: a downturn happened, people were laid-off, eventually factories emptied, factories started hiring again, those employees started buying products again, and the downturn ended.

Now the same thing occurs, but all of the hiring is done in Chinese, Indian, Vietnamese, and other foreign factories. Why would the downturn ever end in the West?

To add to that, economic geniuses like Larry demand that hundreds of thousands of foreigners, mainly Indians, be imported to replace American workers under the guise of H-1B and other visa fictions, yet somehow claim this will create jobs even though historical evidence has proven that their premise is faulty.

And China has used our money wisely, buying naval vessels and other weapons of war so it can keep its status quo.

Larry and Tim “bankers need love too” Geithner gave away many hundreds of billions of dollars to their friends on Wall Street, money that could have been used to save middle class jobs or rebuild infrastructure.

Historians will look back at the period between the start of Reagan’s terms and not that many years from now as the era in which the West voluntarily relinquished its freedom.

Posted by baroque-quest | Report as abusive

Change “eventually factories emptied” to “eventually warehouses emptied.”

Posted by baroque-quest | Report as abusive

Raise the import tariffs in America back to 20%. That’s what we have historically charged, and what China still charges us. No reason we should be giving away access to our markets at the current 1.5% tariff we have slipped to.

This lop-sided arrangement serves multi-national retail business interests, but does not serve American industrial interests.

Posted by AlkalineState | Report as abusive

You thought you needed to be as harsh as the Japanese were to their people. But even in Japan, you can see the balking at the severity of human treatment. It started in the Reagan years here. Tough love and all that stupid BS. “We beat you because we love you”. Oh yes, we all fell for that. You are cruel masters who allow no joy. You beat the masses about the head with fear and shame on a daily basis. You are now the old soviet union and will soon be the middle east, more like Iraq. Liberty and Justice for all is known to be a joke, dummies. Just because you can force someone to publicly state what you want them to say doesn’t mean they truly agree. You can find a few house slaves that will spy on the others, but you are despised by all and hated by most. In other words, you have been so cruel that you have demotivated the entire nation. Only the greedy are on your side.

Posted by brotherkenny4 | Report as abusive

We need to thank Mr. Summers for advancing the theme of “secular” tendencies in capitalism. Once we begin to think outside the framework of business cycles, we can focus our attention on the long-term, historical tendencies in the development of capitalism — if such there be.
One of the first questions that must be addressed has to do with the timeline of our economic system. Is capitalism esentially self-correcting (with or without governmental interventions) and therefore timeless? Or is it time-delimited — essentially a part of the historical development of civilization? If it has not always existed, it must have a birth — perhaps even a demise. Some of you can see where this is headed — to Marx.
At a time like this it would be a good idea for many of us to get back to that unfinished business of taking a closer look at what Marx had to say.

Posted by Anonymous | Report as abusive