It all began at the end of the Great Depression in 1938, when Alvin Hansen, a disciple of John Keynes, suggested a new hypothesis – the “secular stagnation” hypothesis – for the economic situation that was happening at the time. He argued that the U.S. economy would never grow in the same way and that the Great Depression could be the beginning of a new era in which there was no force capable of bringing the economy to full employment, due to persistent unemployment rates and economic stagnation (there was a deterioration of the birth rate and an excessive supply of savings that was repressing the aggregate demand). He claimed that the only remedy was a high and constant government deficit spending. However, this theory was contradicted and lost its strength a few years later: the demand expanded with the increase in government spending caused by the World War II and the problem of excess savings was mitigated by the post–World War II baby boom.
More recently, this theory has recovered its power. On the one hand, we can analyze the case of Japan in the 1990s and the Euro Area’s situation in the last decade: a lower GDP growth, a decline in population growth and a nominal interest rate close to zero. On the other hand, we have the financial crisis of 2008, which is considered by many economists as the worst global financial crisis since the Great Depression. And here, just as Alvin Hansen was referred in the beginning, I must also name Lawrence Summers, who brought this concept back again – he believes this theory is still applied today and that this secular (long-term) stagnation is the main economic problem of our time, particularly if the central banks do not worry about keeping inflation low and the fiscal authorities do not worry about high debt. He says that it may be the reason why U.S. economic growth is not sufficient to reach full employment. With a negative short-term real interest rate, any attempt to expand demand (coming from financial strategies) wouldn’t produce any excess demand – creating a huge difficulty to get the economy back to full employment.
Japan and the Eurozone: Forecast versus Reality
Let’s take this possibility seriously
After Mr. Summers’ speech at the IMF’s Annual Research Conference in 2013, Paul Krugman pointed out some real facts that make the circumstance for secular stagnation disturbingly credible. He started by saying that liquidity trap situations are becoming increasingly common – making monetary policy less effective – and that there is a huge probability of reaching the zero-lower bound. He also denoted a secular descending movement in long-term real interest rates even before the financial crisis of 2008 and an increasingly weak demand – due to the end of ever-increasing leverage and demographic deceleration.
It is reasonable to say that these factors alone can not justify the pure existence of secular stagnation. But, of course, they can create substantial problems in policy terms. In a monetary policy approach, the most credible strategy that can be done under zero-lower bound is to convince the population that the central bank will have an expansionary behavior to create some inflation and high demand (even after the improvement of the economy). However, the central bank must ensure that this inflation target is high enough to produce an economic expansion (and as long as people continue to believe in the monetary authority’s promises). Basically, as Paul Krugman said, “the central bank needs to credibly promise to be irresponsible”. Furthermore, Krugman (2014) shaped these results and created a new concept: the “timidity trap”. This means that, when an inflation target is not high enough, it will have no effect in an economy facing a secular stagnation.
The “timidity trap”
This graph shows an aggregate demand curve that is depending positively on (expected) inflation and a hypothetical non-accelerationist Phillips curve (that demonstrates the dependence of the rate of inflation on output). Additionally, a 2% inflation target is being hypothetically announced by the central bank.
Moving towards fiscal policy matters, Krugman defends that this output gap can be alleviated by an income redistribution from saving people to borrowing people (nevertheless, it should be taken into account the specificities of such procedure). Alternatively, if the problem is temporary, another possibility is an increase in government spending which acts as a demand support until the private sector reaches the normal spending standards. Once that has materialized, monetary policy can continue the process of maintaining demand in regular levels while the government solves its deficit problem. However, these temporary fiscal incentives to support demand may not be sufficient if non-positive natural rates are lasting.
Are they just doomsayers?
Joel Mokyr believes that the observed slow growth in the late 1930s was due to the lack of investment opportunities. In his view, the ongoing technological evolution – that led to higher productivity levels and a huge rise in economic welfare from the mid-19th century – contradicts this so-called secular stagnation. Even though technological improvements may split labor markets, they also generate benefits that are not accurately displayed in current data. In this sense, he claims that measured economic growth underestimates the effect of technology on society’s welfare because there are many products imperfectly quantified.
A new challenge
Many recent studies highlight the negative influence of an ageing society on the growth of its economy. Two possible reasons for this existing negative relationship are that ageing people could generate excessive savings over desired levels of investment; and that there is a lower labor force participation (in addition to lower productivity of older employees).
However, a new research published by the National Bureau of Economic Research and performed by Acemoglu and Restrepo challenges the view of secular stagnation and raises some doubts about this theory: they found that there is no negative relation between slower growth of GDP per capita and population ageing. Therefore, their finding is not in accordance with the widely discussed secular stagnation theory labelled by Lawrence Summers.
So… Gloom or boom?
The different perspectives discussed above allow for a better understanding of the complexity of the challenges faced by the global economy.
On the one hand, we have the pessimists who argue that the economy is buried in a non-existent growth due to the actual depressed aggregate demand and that “sad days are here again” – so policymakers need to adjust their actions to a world that is in trouble. On the other hand, we have those who argue that technological progress proves that pessimists are wrong and defend that the world economy is not suffering from a global imbalance resulting from a fall in the propensity to invest and a growing propensity to save.
I think we must remember that if there is, in fact, a secular stagnation problem, the likelihood of contagion is increased by economic weakness. For now, the central point is that the actual possibility that our economies entered in an age of secular stagnation involves a necessary rethinking of macroeconomic policies.
Margarida Araújo
References
[1] Teulings, C. and Baldwin, R. (2014). “Secular Stagnation: Facts, Causes and Cures“. CEPR Press.
[2] Summers, L. (2014). “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound”. Business Economics.
[3] Krugman, P. (2013). “Bubbles, regulation, and secular stagnation”. The New York Times.
[4] Hansen, A. (1939). “Economic Progress and Declining Population Growth”. American Economic Review.
[5] Acemoglu, D. and Restrepo, P. (2017). “Secular Stagnation? The Effect of Aging on Economic Growth in the Age of Automation”. National Bureau of Economic Research.
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