Lawrence Summers

What to do about secular stagnation?

Lawrence Summers
Jan 6, 2014 12:42 UTC

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.

On secular stagnation

Lawrence Summers
Dec 16, 2013 12:31 UTC

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.