The Secular Stagnation Controversy

by: Timothy Taylor

For economists, the word "secular" isn't about a lack of religious belief. Instead, it refers to whether a condition is expected to last for a long and indefinite period - and in particular, a period not related to whether the economy is entering or exiting a recession. Thus, the concept of "secular stagnation" is the idea that the U.S. economy is not just suffering through the aftereffects of the Great Recession, but is for some reason entering a longer-term period of stagnant growth. Coen Teulings and Richard Baldwin have edited a useful e-book of 13 short essays with a variety of perspectives on Secular Stagnation: Facts, Causes and Cures. In the overview, they write: "Secular stagnation, we have learned, is an economist's Rorschach Test. It means different things to different people."

I've taken a couple of previous cracks at secular stagnation on this blog. I discussed the original theory of secular stagnation as put forward in 1938 in "Secular Stagnation: Back to Alvin Hansen" (December 12, 2013). Hansen was concerned that in the depressed economy of his time, with lower birthrates and a lack of discoveries of new resources and territories, the push of new inventions would not be enough to keep investment levels high and the economy growing. I have also discussed "Sluggish U.S. Investment" (June 27, 2014) in the context of a discussion of secular stagnation by Larry Summers. Here, let me give a sense of how a range of economists are looking at different aspects of the "secular stagnation" issue by quoting (without prejudice against the other essays!) a few sentences from six of the essays.

Larry Summers: "This chapter explains why a decline in the full-employment real interest rate (FERIR) coupled with low inflation could indefinitely prevent the attainment of full employment. . . . Broadly, to the extent that secular stagnation is a problem, there are two possible strategies for addressing its pernicious impacts. ... The first is to find ways to further reduce real interest rates. These might include operating with a higher inflation rate target so that a zero nominal rate corresponds to a lower real rate. Or it might include finding ways such as quantitative easing that operate to reduce credit or term premiums. These strategies have the difficulty of course that even if they increase the level of output, they are also likely to increase financial stability risks, which in turn may have output consequences. ... The alternative is to raise demand by increasing investment and reducing saving. ... Appropriate strategies will vary from country to country and situation to situation. But they should include increased public investment, reductions in structural barriers to private investment and measures to promote business confidence, a commitment to maintain basic social protections so as to maintain spending power, and measures to reduce inequality and so redistribute income towards those with a higher propensity to spend."

Barry Eichengreen: "Pessimists have been predicting slowing rates of invention and innovation for centuries, and they have been consistently wrong. This chapter argues that if the US does experience secular stagnation over the next decade or two, it will be self-inflicted. The US must address its infrastructure, education, and training needs. Moreover, it must support aggregate demand to repair the damage caused by the Great Recession and bring the long-term unemployed back into the labour market."

Robert J Gordon: "US real GDP has grown at a turtle-like pace of only 2.1% per year in the last four years, despite a rapid decline in the unemployment rate from 10% to 6%. This column argues that US economic growth will continue to be slow for the next 25 to 40 years - not because of a slowdown in technological growth, but rather because of four 'headwinds': demographics, education, inequality, and government debt."

Paul Krugman: "Larry Summers' speech at the IMF's 2013 Annual Research Conference raised the spectre of secular stagnation. This chapter outlines three reasons to take this possibility seriously: recent experience suggests the zero lower bound matters more than previously thought; there had been a secular decline in real interest rates even before the Global Crisis; and deleveraging and demographic trends will weaken future demand. Since even unconventional policies may struggle to deal with secular stagnation, a major rethinking of macroeconomic policy is required."

Edward L Glaeser: "US investment and innovation - the most standard ingredients in long-run economic growth - are not declining. The technological world that surrounds us is anything but stagnant. Yet we can have little confidence that the continuing flow of new ideas will solve the US's most worrying social trend: the 40-year secular rise in the number and share of jobless adults. ... The massive secular trend in joblessness is a terrible social problem for the US, and one that the country must try to address. I do not believe that this is a macroeconomic problem that can be solved with more investment or tax cuts alone. . . . Alongside targeted investments in education and training, radical structural reforms to America's safety net are needed to ensure it does less to discourage employment."

Gauti B. Eggertsson and Neil Mehrotra: "Japan's two-decade-long malaise and the Great Recession have renewed interest in the secular stagnation hypothesis, but until recently this theory has not been explicitly formalised. This chapter explains the core logic of a new model that does just that. In the model, an increase in inequality, a slowdown in population growth, and a tightening of borrowing limits all reduce the equilibrium real interest rate. Unlike in other recent models, a period of deleveraging puts even more downward pressure on the real interest rate so that it becomes permanently negative."

Richard C. Koo: "The Great Recession is often compared to Japan's stagnation since 1990 and the Great Depression of the 1930s. This chapter argues that the key feature of these episodes is the bursting of a debt-financed asset bubble, and that such 'balance sheet recessions' take a long time to recover from. There is no need to suffer secular stagnation if the government offsets private sector deleveraging with fiscal stimulus. However, until the general public understands the fallacy of composition, democracies will struggle to implement such policies during balance sheet recessions."

Volumes like this feel a bit like the parable of the blind men and the elephant, where each man grabs one part of the elephant and then declares what an elephant feels like, depending on whether the man has a leg, tail, trunk, ear, tusk, side, or belly of the elephant. It's easy to grab hold of one part of the economy, but it can be difficult to see the interactions across the parts, or to see it as a whole.