Sluggish economic growth has generated a number of catch phrases to describe the collective experience – “lost” decades, secular stagnation, the Japanese disease. There can be little doubt that the U.S. has been living through such a period. The expansion since June 2009, the trough of the last recession, is nearing the record set in the 1990s, 120 months, but no one will mistake the last 10 years for the wild and wooly ‘90s.
True, the unemployment rate is today very low. But GNP growth itself has been sub-par, wages have risen only slowly, interest rates have remained low, inflation has stayed below target, and the federal deficit has grown instead of vanishing. That’s what Lawrence Summers had in mind in 2013 when he revived the long-ago prophecy of his Harvard predecessor Alvin Hansen to warn of secular stagnation.
How long? Indefinitely, answered Summers, without a considerable overhaul of the economic dogma that informs politics and policy.
Summers reiterated all this earlier this month in a paper with Lukasz Rachel, of the London School of Economics, a leader of the rising generation of macroeconomists, at the spring meeting of the Brookings Panel on Economic Activity. A savings glut developed over the course of the last generation was driving down the so-called neutral rate of interest – the point at which savings and investment balance at full employment. Bubbles and other sorts of asset misallocation remain a threat as long as interest rates remain low and out of alignment.
Bigger government deficits than those now considered prudent will be required, the economists say, to soak up private savings on the one hand, and, on the other, devise novel long-term investments designed make private investment attractive again.
This time Summers added a further warning. Given that central banks have slashed their lending rates by 5 percentage points or more to combat recessions in the past, “there is the question of whether enough room can be generated to stabilize the economy when the next recession hits.” Monetary policy may have reached its limits.
Rachel and Summers’s analysis is technical economics. You can read it here. Financial Times columnist Martin Wolf’s account of their paper is here. Summers added some details in an op-ed article in The Washington Post that makes the argument less of an abstraction.
Hansen, an early convert to Keynesian views and for some years thereafter its leading American apostle, had feared that demographic trends and diminishing technological opportunities were reaching a point at which only government deficit spending could keep the economy at full employment.
[It was in his presidential address to the American Economic Association, in 1938, that Hansen spelled out his view. Slowing population growth, the closing of the American frontier, and the end of the 19th Century capital-goods boom would mean “sick recoveries which die in their infancy and which feed on themselves and leave a hard and unmovable core of unemployment.”]
That didn’t happen, writes Summers. “Sufficient remedies were found initially in wartime military spending, then in massive national projects such as building out the suburbs and reducing saving by allowing Social Security to meet retirement needs and making consumer credit widely available.” But with the extravagant growth of private savings around the world since the 1980s, perhaps the situation that Hansen feared has risen anew. Summers writes in the op-ed:
What has happened to private saving and private investment? Many things, including increases in saving caused by people having fewer children, more inequality, longer retirement periods and increased uncertainty. Probably more important, demand for private investment has fallen off as the economy’s structure has changed. Computing power costs a tiny fraction of what it used to. Malls have been replaced by e-commerce. People prefer small urban apartments to large suburban houses. Cars and appliances need to be replaced less often. In any event, the end of labor force growth means less demand for new capital.
In their paper, much the news Rachel and Summers offer is empirical. Real interest rates would have declined far more over the last fifty years, the economists say, if it weren’t for the large increases in government debt, pay-as-you-go pensions, and public health insurance expenditures that were put in place by, among other things, “the Reagan revolution.” That neutral rate of interest, a conceptual apparatus designed to guide central bank policy, may have declined as much as 7 percentage points since 1970s, as savings have grown and tempting private investment opportunities have shrunk. The neutral rate would be several percentage points negative without the run-up to the level today’s trillion-dollar annual deficit. Summers continued.
The traditional Keynesian view, in which permanent depression is possible, is more right than the New Keynesian approach in which employment is attributed only to temporary price rigidities.
What to do, then, about all those private savings seeking “yield,” or at least a seemingly fair return? Summers offers a short list of options: bigger budget deficits, improved Social Security designed to reduce retirement savings, redistributions of income to poorer consumers with higher spending propensities, reductions in monopoly power, investment mandates (such as the retirement of coal-fired power plants) and other investment incentives.
Are there any changes in the offing of comparable magnitude to those that after World War II made Alvin Hansen seem an alarmist? Perhaps. The world seems to be selling again into a long-lasting global contest, this time between the United States and China. The problem posed by global warming is very real; what remains to be seen is the alacrity with which it is taken up.
And it’s worth remembering that all this takes place against the backdrop of the narrative that Thomas Piketty set out in 2014. In Capital in the Twenty-First Century (Harvard), the French economist reintroduced an argument even older than secular stagnation – the proposition that the rich were getting richer much faster that the world economy was growing, and that this inequality was profoundly destabilizing
A decade after the financial crisis cast macroeconomics into low regard, it is back in style.
David Warsh, a veteran political and economist essayist, and an economic historian, is proprietor of Somerville-based economicprincipals. com, where this piece first ran.