What to do about secular stagnation?

By Lawrence Summers
January 6, 2014

Last month in this space I argued that we may be in a period of secular stagnation in which sluggish growth, output and employment at levels well below potential, and problematically low real interest rates might coincide for quite some time to come. Since the beginning of this century U.S. GDP growth has averaged less than 1.8 percent per year. Right now the economy is operating at nearly 10 percent — or more than $1.6 trillion — below what was judged to be its potential path as recently as 2007. And all this is in the face of negative real interest rates out for more than 5 years and extraordinarily easy monetary policies.

It is true that even some forecasters who have had the wisdom to remain pessimistic about growth prospects for the last few years are coming around to more optimistic views about growth in 2014, at least in the U.S. This is encouraging, but optimism should be qualified by the recognition that even optimistic forecasts show output and employment remaining well below previous trends for many years. More troubling even with the current high degree of slack in the economy and wage and price inflation slowing, there are increasing signs of eroding credit standards and inflated asset values. If we were to enjoy several years of healthy growth with anything like current credit conditions, there is every reason to expect a return to the kind of problems we saw in 2005-2007 long before output and employment returned to trend or inflation accelerated.

The secular stagnation challenge then is not just to achieve reasonable growth, but to do so in a financially sustainable way. What then is to be done? Essentially three approaches compete for policymakers’ attention. The first emphasizes what is seen as the economy’s deep supply side fundamentals — the skills of the workforce, companies’ capacity for innovation, structural tax reform, and assuring the long-run sustainability of entitlement programs. All of this is intuitively appealing, if politically difficult, and would indeed make a great contribution to the economy’s health over the long run. But it is very unlikely to do much over the next 5 to 10 years. Apart from obvious lags like those with which education operates, there is the reality that our economy is constrained by lack of demand rather than lack of supply. Increasing our capacity to produce will not translate into increased output unless there is more demand for goods and services. Training programs or reform of social insurance, for instance, may affect which workers get jobs, but they will not affect how many get jobs. Indeed measures that raised supply could have the perverse effect of magnifying deflationary pressures.

The second strategy that has dominated U.S. policy in recent years has been lowering relevant interest rates and capital costs as much as possible and relying on regulatory policies to assure financial stability. No doubt the economy is far stronger and healthier now than it would be in the absence of these measures. But a growth strategy that relies on interest rates significantly below growth rates for long periods of time is one that virtually insures the emergence of substantial financial bubbles and dangerous buildups in leverage. It is a chimera to hold out the hope that regulation can allow the growth benefits of easy credit to come without the costs. Increases in asset values and increased ability to borrow stimulate the economy and are precisely the proper concern of prudential regulation.

The third approach — and the one that holds the most promise — is a sustained commitment of policy to raising the level of demand at any given level of interest rates through policies that restore a situation where reasonable growth and reasonable interest rates can coincide. To start, this means ending the disastrous trends towards less and less government spending and employment each year, and taking advantage of the current period of economic slack to renew and build out our infrastructure. In all likelihood, if the government had invested more over the last 5 years, our debt burden relative to income would be lower today given the way in which economic slack has hurt the economy’s long-run potential, so it would not have imposed any burden on future taxpayers.

Raising demand also means seeking to spur private spending. There is much that can be done in the energy sector to unleash private investment on both the fossil fuel and renewable sides. Regulation that requires the more rapid replacement of coal-fired power plants will increase investment and spur growth as well as help the environment. And it is essential to insure in a troubled global economy that a widening trade deficit does not excessively divert demand from the U.S. economy.

Secular stagnation is not an inevitability. With the right policy choices, we can have both reasonable growth and financial stability. But without a clear diagnosis of our problem and a commitment to structural increases in demand, we will be condemned to oscillating between inadequate growth and unsustainable finance. We can do better.

PHOTO: Morning commuters walk past the New York Stock Exchange August 20, 2012. REUTERS/Brendan McDermid 

22 comments

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Nice theories.

Training didn’t do any good when the jobs are being created elsewhere.

Low interest rates didn’t do good either, as much got invested outside of US by the borrowers having no impact on local jobs.

Interesting – your call for more government spending and energy regulation (from coal to other) – exact opposite of your call in one of your prior articles – is refreshing and perhaps the result of some wisdom dawned over time. This, may have some impact but bottom-line, but if you don’t stop the incessant flow of duty-free imports, your call for demand holds no prayer and we continue to pile-up about $40B/month trade-gap consistently, to our own eventual demand doom.

Posted by Mott | Report as abusive

Liberal claptrap, period. Even the first option includes additional government spending (entitlement programs). The answer to the economy is to reduce government intrusion into business and stop trying to regulate winners and losers. The American economy is trying desperately to recover, but the current policies do not allow for recovery.

Options two and three are even worse, and reflect that the author is not grounded in reality. The government consumes too much of the American output, and does not do an efficient job at just about anything it attempts. Putting more money there simply means that the bureaucracy wastes more resources.

Posted by stevedebi | Report as abusive

His option three is only a temporary fix that requires growth to return to “normal”. Well, it ain’t. Not for at least the next 3-5 decades. Automation will continue to suck jobs out of our economy, the Chinese will replace us as the largest economy, and will lose the reserve currency. These are just plain going to happen. Emerging economies will continue to have growth, but only for a short time as automation catches up to them too.
We need a new economic theory that will account for the changes in the 21st century. Mainly that we cannot employ all people anymore. That means no demand for products as they don’t have jobs.

Posted by tmc | Report as abusive

“Apart from obvious lags like those with which education operates, there is the reality that our economy is constrained by lack of demand rather than lack of supply.”

This is no surprise or mystery to anyone who understands the inverse relationship between population density and per capita consumption. America’s heavy reliance on population growth (primarily through high rates of immigration) to stoke economic growth is counter-productive, driving down per capita consumption at nearly the same rate that it drives up total consumption.

Pete Murphy
Author, “Five Short Blasts”

Posted by Pete_Murphy | Report as abusive

@tmc – “..no demand for products as they don’t have jobs”

The above, nicely sums up the root-cause of fall in demand. Fancy theories are just superfluous.

Posted by Mott | Report as abusive

There is a fourth option – recognise that we don’t have to consume endlessly and that leisure is a “service” that can be consumed as well. Get the unemployed back to work (through public projects if necessary), but everyone work less.

Read “The Affluent Society” by John Kenneth Galbraith for a superb dissertation on exactly this subject. It foresaw by 50 years the problems we are facing today.

And don’t bother telling me that the Chinese will eat our lunch. Leisure is not a service which the Chinese can export. They only salivate if we continue to consume goods without end.

Relax and enjoy life.

Posted by RAD61 | Report as abusive

Larry, Larry, Larry, you have eyes yet cannot see.

Our economy is 10% below estimates from 2007 even with “negative real interest rates”…for more than 5 years and extraordinarily easy monetary policies”. Did you miss that economic convulsion some call the “Great Recession” that signaled the end of “then” and the beginning of “now”?

“…the skills of the workforce…” are what they are. We have people with basic and advanced college degrees flipping burgers. Is it not obvious that increasing training for positions that are decreasing in number is not logical, cost-effective or even useful in the long run?

“Companies’ capacity for innovation is being utilized with stunning success to break down “good paying full time jobs with benefits” into positions that part-timers with only basic math and English can master in two weeks “on the job”. Such minimal qualifications mean such jobs are professional “dead ends” that lead no where and those doing them become like light bulbs…burn out one, insert the next. Welcome to the future. There’s no turning back.

Structural tax reform of, substance would require a sense of “common cause” long lacking in Washington. The only way to assure “…the long-run sustainability of entitlement programs…” is to continue selling the idea that Social Security is no different than the others, and go after them all with a sharp fiscal ax.

Both side of the isle in Washington are preparing to welcome with the open wallets of working Americans some twenty million plus illegal aliens. Those “…entitlement programs…” will predictable EXPLODE in terms of tax revenue necessary to sustain them.

Yet already the purchasing power of existing Americans on Social Security is under attack by the LIBERALS and a “chained index” that even more divorces payments from the realities of government-desired inflation. Our OWN GOVERNMENT will be the instrument of impoverishment of every retiring American as this century unfolds.

“…our economy is constrained by lack of demand rather than lack of supply. Increasing our capacity to produce will not translate into increased output…”. You got it! Yes, increasing production WILL magnify “…deflationary pressures.”

A “…growth strategy that relies on interest rates significantly below growth rates for long periods of time…”, as Mott points out, has driven substantial capital from this country to wherever it can earn a reasonable return. Gee, who would have guessed?

What will be the likely “level of interest rates” once our population stabililzes (or even begins to shrink)? Demand, in turn, can only follow.

“…less and less government spending and employment each year…” will be the sole means by which this country can remain solvent. The “…right policy choices…” must be to dump Davis-Bacon before putting shoulder to wheel and rebuilding our infrastructure. Those funds must be extracted from less necessary federal obligations.

It is time to end the reality that the nearest thing to eternal life on this planet is a government program. We need to “Sunset” them all and let a “Darwinism of necessity” determine the survivors.

The very idea that the federal government can make “structural increases in demand” (other than in times of war) is but a silly political illusion that infects both of our major parties.

Posted by OneOfTheSheep | Report as abusive

TMC you are right on. Completely new theories and the universities are beginning to work on this. Another reason the demand is down, is because people are learning not to buy a bunch of stuff they do not need, just for the sake of buying stuff. We do not need or want much of what China has to offer. The trade agreements need to go away, they are real killers. Legalization of plants will save the economy.

Posted by 2Borknot2B | Report as abusive

Shutting down fossil fuel plants (and replacing them with nuclear, the only viable alternative at the present time) is an excellent idea to save the habitable zone of the planet, but probably won’t do much for employment. And it isn’t really the job of the government to create employment or entitlements, as though they were some kind of a right apart from economic reality. But it is the job of the government to regulate the financial industry to prevent banks from speculating with private money at public expense, and to provide infrastructure to support economic growth, which it isn’t doing very well at the moment.

The above list indicates the real problem: you need both “liberal” policies in some areas and “conservative” policies in other areas. Can you imagine either of the two parties delivering on that? Not in my lifetime. It is time to get realistic about what government can and should do, which probably means a third party.

Posted by Jim1648 | Report as abusive

Investment in “infrastructure” without legitimate demand in the form of real manufacturing jobs is totally pointless and absurd.

What is desperately needed is a total reversal of the trends of the past 30 years that drove this country into this prolonged recession, by which I mean the tax, banking and trade legislation that favors only the wealthy class at the expense of this nation.

Posted by EconCassandra | Report as abusive

@EconCassandra, reversing the last 30 years is impossible. You cannot turn the clock back to your favorite time period. Just changing a few regulations and laws will not bring back those times. Doing so would cause much more harm than good. The entire world society and economy changed too.

Posted by tmc | Report as abusive

Larry, if your expectations keep failing to come true, change your expectations and stop chasing chimeras.

Most Americans realize that the Fed’s QE has reached its zero productivity level around two and a half years ago, and since then it’s been damaging our economy at an increasing pace.
There is no escape from the law of diminishing returns, and although most Americans don’t have a good economic education, they get it intuitively: Too much of a good thing is bad, and more of it makes things much worse.
Few people are impressed by the current stock bubble, and most people see it for what it is: a bubble, and therefore a clear sign of mis-allocated funds and a potential for yet another catastrophe when it bursts, as bubbles do, eventually. People know that already, at least most of them.
Through its recent extreme policies, The Fed has become a source of economic uncertainty and a malaise magnifier. People act according to their own expectations, and over time most of them become immune to hype – especially if it’s the same hype and they’ve had a chance to test it.

Posted by reality-again | Report as abusive

I agree with LS that investment in infrastructure and legislated incentives to force change in the energy sector are the best ideas for encouraging further growth in the economy. This will create jobs across the spectrum of employment, and most importantly, for blue collar workers, those without a college degree. Local governments especially have been gutted by the collapse of the housing market. City, county and state budgets contract out most of their work to local small businesses in their area. Without money to spend for these local projects, many small businesses go under or cut back drastically on their employment.
And it isn’t a question of whether or not the US has the money. The US has plenty of money. It’s just a question of where we want to spend it, here or overseas.

Posted by thinkb4 | Report as abusive

America had the worlds largest, most lucrative market: itself.

America, since the days of George Washington and Alexander Hamilton, had always, always, protected itself with a strong protective tariff.

Then came the snake-oil salesmen, telling us that globalization would be a wonderful thing. (What they meant was that it would be wonderful for them, not us.)

America, with the largest and richest middle class of all the countries in the world, had the most to lose from globalization. And now we have lost it, our amazing middle class.

The American people have been betrayed, stabbed in the back, by a small wealthy elite who have gained immensely by globalization.

Posted by AdamSmith | Report as abusive

.
Demand constraints could be addressed by switching the federal government to pure bond financing.

That means abolishing corporate and personal income taxes and raising revenue through floated bonds paid off by QE type operations.

Federal taxation has not been necessary since the gold standard was abolished.

Inflation could be controlled through interest rates, bank reserve requirements, spending restraint and the like.

All income earners would have more to spend at the risk of higher interest rates. Unproductive tax collection and tax avoidance activities would largely cease.

There are political advantages as well in the sense that federal spending becomes easier to effect and the endless tax level debate would no longer exist.
.

Posted by AvraamJDectis | Report as abusive

@AdamSmith,

Same story, different perspective. America has always held itself up as a shining example of self-determination. Until recently, we didn’t really need the “”market protection” tariffs provide. American businesses had the “American economy” as their own “private fishing pond” because the great distance separation of the oceans made goods shipped from elsewhere enough more expensive that any price advantage they might have was lost.

Then “foreigners” came here and developed their own educational systems such that they could manufacture efficiently, and the design, registration and operating costs of ever-larger tankers and container ships reduced the cost of shipping to insignificance. Their cheaper labor costs enabled their products to “eat our lunch” and take over whole segments of manufactured products.

Our “largest and strongest” middle class, possible only because America was the “Arsenal of Democracy” in WW II, Korea and the Cold War without ever having actual fighting and associated damage within the continental United States, has today realized it’s very existence was but a temporary aberration of history. Welcome to reality, folks. Foreign businessmen taking America at it’s word and out-competing us to do certain things are not “snake oil salesmen”. They are honest global competitors.

Anyone feeling “betrayed” or “stabbed in the back” must be part of one of our many generations raised to only know good times. They don’t understand periodic economic cycles or that they are ENTITLED to NOTHING just for showing up. Everyone doesn’t get a trophy.

A small enterprising elite who can look ahead and put together ventures that profit from globalization are doing so, hugely resented by the ever-envious hammer and saw wielders, the non-tenured university staff and burger flippers, etc. that know not how to participate profitably in the “new global economy”. Suck it up!

It ain’t that hard, folks…find a need and fill it; or figure out how to make whatever you can do needed by someone able and willing to pay you. In this regard it helps if you have decent teeth, aren’t covered in tattoos and/or body piercings, speak reasonably understandable English and understand enough math to make accurate change. Oh, I just described the hard core unemployed? Who’d a thought it?

Posted by OneOfTheSheep | Report as abusive

I think “secular stagnation” is a fancy name to the realization that constant quantitative growth is simply impossible in a closed and finite natural system where humanity interconnected into a globally interdependent “super-organism”.
We can imagine a picture where cancer cells, used to taking for themselves as much as they wanted, way beyond their natural necessities, endlessly growing, blowing bubbles at the expense of others and the environment, suddenly realize that unless they learn how to use the interconnections in between them in a mutually benevolent, mutually complementing way, neither them or the system will survive.
We each have become cells and organs of this “human super-organism” and together we have to learn what our roles are in this living, integral system, how much we need for our optimal functioning, how much we need to contribute to the whole so it remains healthy and sustainable and live our lives accordingly.
It is a very simple system, everybody receives from the system 100% according to their 100% mutual contribution according to their necessities but not more.
There will still be leaders, CEOs living in penthouses traveling in limousines, and simple farmers traveling on horseback or bicycles living in small houses, but exactly according to what they need so they can contribute to the society in their best possible way.
So far we operated like huge storehouses along a railway line, although the freight train started with enough for everybody to live a normal, healthy lifestyle, since the first stations took everything the could stuff into their storehouses regardless of their necessities, after the first couple of stops the train has become empty.
We will not be able to operate like this any longer.
New life based on natural necessities, and available resources.

Posted by ZGHermann | Report as abusive

Pretty good post there @ZGHermann. I like your thought line.
@OTSS my friend, you are a self contained conundrum. You are correct in many ways. But so is @JL4.

It is nice to know that many people see what is truly happening. We all don’t agree on a solution yet and probably never will, but it’s nice to see we’re all looking for one.

Posted by tmc | Report as abusive

@tmc,

“…a self-contained conundrum…”? Thank you. That compliment indicates that you, too, understand there are many yin-yang interrelationships that make political and/or economic “solutions” complicated (and difficult).

You are a thinker with an open mind. As the saying goes, when two people always agree, one of them is unnecessary. I comment on Reuters in the hope that there are legions “out there” like you, a “silent majority” that does not comment but regularly reads comments.

Reality in the “real world” seldom aligns itself with any specific political or economic policy. Accordingly, anyone genuinely looking for the “best compromise” (and it will ALWAYS be a compromise) must look beyond the blinders of personal interest and/or partisanship and perceive the conflicting and competing interests in every challenge.

JL4 made no comment in this thread. She has limited experience and perspective and WAY too much anger to take seriously very often. Even the clock that is stopped is right twice a day.

Posted by OneOfTheSheep | Report as abusive

A summary of Summer’s article…”Perot was correct”.

That giant sucking sound that Perot was criticized for in the 1980′s is our current reality. We opened our shores to production from other countries and our jobs went with it.
Throw in the EPA that kills virtually any industry that creates “emissions” such that even light manufacturing has been outsourced.

And, when one adds in 11+ million illegals “doing the jobs Americans won’t do” (really?) in spite of the fact it was Americans (not illegals) that built virtually every home and building, the national infrastructure, supplied two World Wars and countless other conflicts, and poured every yard of concrete, for almost two centuries.

Anyone who believes that the immigration “reform” AND more entitlements (income redistribution) promoted by the POTUS and his minions will make things better is delusional. It will kill job creation for AMERICANS willing to work for the next 50 years.

The problem, unequivocally, is the POTUS and Congress. The buck stops there!

Posted by COindependent | Report as abusive

Dearest Larry and Gavin, “We have the financial and the ever-improving technological capabilities to ensure that a child born anywhere in the world can live a long, healthy life.” WE HAVE THE CAPABILITY TO DO THIS RIGHT NOW IN AMERICA WITH UNIVERSAL HEALTH CARE. We can save the world after we save ourselves. MOTO = Honesty, Responsibility, CARE OF SELF, then care of others.

“By making sure life-saving medicines, vaccines, malaria bed nets, diagnostic tests and other health tools are delivered to everyone” IN THE USA VIA UNIVERSAL COVERAGE, “we could dramatically cut deaths caused by the traditional scourges of the poor world” — POOR DIETS, POLLUTED WATER AND LANDS, POVERTY, CANCER and “like AIDS, TB, malaria, and childhood pneumonia and diarrhea — to low levels everywhere.”

“Achieving such a grand convergence” RIGHT HERE AND NOW ! “would close the global health gap.” That would improve the quality of life for all Americans and would simultaneously increasing human happiness, and that would increase individual choices and their productivity in their personal lives, and that in turn boosts social, scientific and economic growth.

Posted by 2Borknot2B | Report as abusive

Lawrence Summers is a fine fellow and, like the majority of today’s economists, well grounded in the economics of the Great Depression as presented by Keynes and Hayek eighty years ago for the UK economy. Thus in this article he presents the two Keynesian policy concepts of lower short term rates to encourage investment and more government spending.

Alas for his solutions, economic institutions have changed in eighty years and the US economy and its central bank do not function as the UK’s did eighty years ago; similarly the UK centralized budget process is totally different from that of the UK.

The problem is simple: today’s economic thinking is still dominated by the eighty years old UJ-oriented theories and policies of the great economists of that era – Keynes and Hayek instead of those of the great economists of this era – Stigler and Lindauer.

Thus we hear the old economists and their students still looking at the Fed’s target rate of interest and thinking it comparable to the UK’s bank rate at which the banks can borrow money to loan for businesses and consumers. One has to be quite naive, or at least a Federal Reserve governor, to believe that a US commercial banker will borrow money that has to be repaid in 24 hours and loan it out for months and years so people can buy houses and cars and businesses can buy equipment and have sufficient working capital. Same with government spending – the UK is centralized and its parliament controlled by the government. Fiscal changes can occur quickly. The United States has decentralized governments and checks and balances – a fiscal change takes years and years, not days as in the UK.

Summers’ naive answers are not, and cannot, be the basis for an economic recovery. And we can not get there by reducing or imposing regulations (Hayek) or lowering short term rates or increasing Federal Spending (Keynes). It’s the theories and policies of Stigler and Lindauer that apply today, not those of eighty years ago.

Posted by Macroeconomist | Report as abusive