Search Results for: secular stagnation

Responding to some of the critiques of our paper on secular stagnation and fiscal policy

March 20th, 2019

My paper with Lukasz Rachel on secular stagnation and fiscal policy summarized here has attracted a number of interesting responses including from Martin Wolf, David Leonhardt, Martin Sandbu and Brad DeLong and also many participants at the Brookings conference.

I’m gratified that there seems to be general acceptance of the core secular stagnation argument. “Normal” policy settings of real interest rates in the 2 percent range, balanced primary budgets and stable financial markets are a prescription for stagnation and underemployment. Such economic success as the industrial world has enjoyed in recent decades has reflected a combination of very low real rates, big budget deficits, private leveraging up and asset bubbles.

No one from whom I have heard doubts the key conclusion that a combination of meaningfully positive real interest rates and balanced budgets would likely be a prescription for sustained recession if not depression in the industrial world.

Notice that this is a much more fundamental argument than the suggestion that the some effective lower bound on interest rates may impede stabilizing the economy. The argument is that because of chronic private sector tendency towards oversaving, economies may be prone to underemployment and financial stability absent policy responses which are themselves problematic.

This is an argument much more in the spirit of Keynes, the early Keynesians, and today’s Post-Keynesians than the New Keynesians who have set the terms for much of contemporary macroeconomic discourse both in academia and in the world’s central banks.

The central feature of New Keynesian models is an idea that economies have an equilibrium to which they naturally revert independent of policies pursued. Good central bank policy achieves a desired inflation target (assumed to be feasible) while minimizing the amplitude of fluctuations around that equilibrium.

In contrast contemporary experience, where inflation has been below target almost throughout the industrial world for a decade and is expected by markets to remain below target for decades, and where output is sustained only by large budget deficits or extraordinary monetary policies, suggest that central banks acting alone cannot necessarily attain inflation targets and that misguided policy could easily not just raise the volatility of output but also reduce its average level.

While there seems to be little doubt that real interest rates–short and long, ex ante and ex post — have declined very substantially even as (other things equal) budget deficits and expanded social security programs should have increased them, there remains debate about how to analyze these trends. Lukasz and I argue that adjustment to balance saving and investment is the best way understand declining real rates. DeLong wonders about changing risk premiums and Wolf cites BIS work arguing that low rates reflect the monetary policy regime. There is no reason why there needs to be only one cause of low real rates so these factors may enter. But as I expect we will illustrate in the revised version of the paper, the largest part of the low frequency variation in ex ante real returns is accounted for by a downward trending factor common to all asset prices. This is illustrated for the US in the figure below. So risk premiums or factors specific to Treasuries are likely not high order.

Figure: Decline in US real asset returns









Granting that secular stagnation is a problem, there is the question of policy response. The right policy response will be the one that assures that full employment is maintained with a minimum of collateral problems. Sandbu argues against the notion of secular stagnation in part because he thinks it may lead in unconstructive directions like protectionism and because he believes that stagnation issues can be feasibly and relatively easily addressed by lowering rates. Wolf, relying on the BIS, is alarmed by the toxic effects of very low rates on financial stability in the short run and economic performance in the long run, and prefers fiscal stimulus. Leonhardt prefers a broad menu of measures to absorb saving and promote investment.

I am not certain of the right approach and I wish there was more evidence to bring to bear on the question. I can certain see the logic of the “zero is just another number” view, that holds that the current environment poses no new fundamental issues but just may require technical changes to make more negative interest rates possible. I am skeptical because (i) I am not sure how large the stimulus effect of rates going more negative is because of damage to banks, reduced interest income for consumers, and because capital cost is already not the barrier to investment; (ii) I wonder about the quality of any investment that was not made at a zero rate but was made at a negative rate; and (iii) I suspect that a world of significantly negative nominal rates if sustained will be a world of leveraging, risk seeking and bubbles. I have trouble thinking about behavior in situations where people and firms are paid to borrow!

I am inclined to prefer more reliance on reasonably managed fiscal policies as a response to secular stagnation: government borrowing at negative real rates and investing seems very attractive in a world where there are many projects with high social returns. Moreover, we are accustomed to thinking in terms of debt levels but it may be more appropriate to think in terms of sustained debt service levels. With near zero rates these are below average in most industrial countries. The content of fiscal policies is crucial. Measures which run up government debt without stimulating demand like large parts of the Trump tax cut are ill advised. In contrast measures which promote investment and raise the tax base down the road are much more attractive.

There are of course other measures beyond stabilization policies like fighting monopolies, promoting a more equal income distribution, and strengthening retirement security for which the desire to maintain macroeconomic stability provides an additional rationale.

Setting the Record Straight on Secular Stagnation

September 3rd, 2018

Joseph Stiglitz recently dismissed the relevance of secular stagnation to the American economy, and in the process attacked (without naming me) my work in the administrations of Presidents Bill Clinton and Barack Obama. I am not a disinterested observer, but this is not the first time that I find Stiglitz’s policy commentary as weak as his academic theoretical work is strong.

Stiglitz echoes conservatives like John Taylor in suggesting that secular stagnation was a fatalistic doctrine invented to provide an excuse for poor economic performance during the Obama years. This is simply not right. The theory of secular stagnation, as advanced by Alvin Hansen and echoed by me, holds that, left to its own devices, the private economy may not find its way back to full employment following a sharp contraction, which makes public policy essential. I think this is what Stiglitz also believes, so I don’t understand his attacks.

In all of my accounts of secular stagnation, I stressed that it was an argument not for any type of fatalism, but rather for policies to promote demand, especially through fiscal expansion. In 2012, Brad Delong and I argued that fiscal expansion would likely pay for itself. I also highlighted the role of rising inequality in increasing saving and the role of structural changes toward the demassification of the economy in reducing demand.

What about the policy record? Stiglitz condemns the Obama administration’s failure to implement a larger fiscal stimulus policy and suggests that this reflects a failure of economic understanding. He was a signatory to a November 19, 2008 letter also signed by noted progressives James K. Galbraith, Dean Baker, and Larry Mishel calling for a stimulus of $300-$400 billion – less than half of what the Obama administration proposed. So matters were less clear in prospect than in retrospect.

We on the Obama economic team believed that a stimulus of at least $800 billion – and likely more – was desirable, given the gravity of the economic situation. We were told by those on the new president’s political team to generate as much validation as possible for a large stimulus because big numbers approaching $1 trillion would generate “sticker shock” in the political system. So we worked to encourage a variety of economists, including Stiglitz, to offer larger estimates of what was appropriate, as reflected in the briefing memo I prepared for Obama.

Despite the incoming president’s popularity and an all-out political effort, the Recovery Act passed in Congress by the thinnest of margins, with doubts about its ultimate passage linger until the last moment. I cannot see the basis for the argument that a substantially larger fiscal stimulus was feasible. And the effort to seek a much larger one certainly would have meant more delay at a time when the economy was collapsing – and could have led to the defeat of fiscal expansion.

While I wish the political climate had been different, I think Obama made the right choices in approaching fiscal stimulus. It is of course also regrettable that after the initial Recovery Act, Congress refused to support a variety of Obama’s proposals for infrastructure and targeted tax credits.

Unrelated to the topic of secular stagnation, Stiglitz takes a swipe at me by saying that Obama turned to “the same individuals bearing culpability for the under-regulation of the economy in its pre-crisis days” and expected them “to fix what they had helped break.” I find this a bit rich. Under the auspices of the government-sponsored enterprise (GSE) Fannie Mae, Stiglitz published a paper in 2002 arguing that the chance that the mortgage lender’s capital would be depleted was less than one in 500,000, and in 2009 he called for nationalization of the US banking system. So I would expect Stiglitz to be well aware that hindsight is clearer than foresight.

What about the Clinton administration record on financial regulation? With hindsight, it clearly would have been better if we had foreseen the need for legislation like the 2010 Dodd-Frank reforms and had a way to enact it with a Republican-controlled Congress. Certainly we did not foresee the financial crisis that came eight years after we left office. Nor did we anticipate the ways in which credit default swaps would mushroom after 2000. We did, however, advocate for GSE reform and for measures to rein in predatory lending, which, if enacted by Congress, would have done much to forestall the accumulation of risks before 2008.

I have not seen a convincing causal argument linking the repeal of the Glass-Steagall Act and the financial crisis. The observation that most of the institutions involved – Bear Stearns, Lehman Brothers, Fannie Mae, the GSE Freddie Mac, AIG, WaMu, and Wachovia – were not covered by Glass-Steagall calls into question its centrality.

Yes, Citi and Bank of America were centrally involved, but the activities that generated major losses were fully permissible under Glass-Steagall. And, in important respects, the repeal of Glass-Steagall actually enabled the resolution of the crisis, by permitting the merger of Bear and Merrill Lynch and by allowing the US Federal Reserve to open its discount window for Morgan Stanley and Goldman when they otherwise could have been sources of systemic risk.

The other principal attack on the Clinton administration’s record targets the deregulation of derivatives in 2000. With the benefit of hindsight, I wish we had not supported this legislation. But, given the extreme deregulatory approach of President George W. Bush’s administration, it defies belief to suggest that it would have created major new rules regarding derivatives but for the 2000 act; so I am not sure how consequential our decisions were. It is also important to recall that we pursued the 2000 legislation not because we wanted to deregulate for its own sake, but rather to remove what the career lawyers at the US Treasury, the Fed, and the Securities and Exchange Commission saw as systemic risk arising from legal uncertainty surrounding derivatives contracts.

More important than litigating the past is thinking about the future. Even if we disagree about past political judgements and about the use of the term “secular stagnation,” I am glad that an eminent theorist like Stiglitz agrees with what I intended to emphasize in resurrecting that theory: We cannot rely on interest-rate policies to ensure full employment. We must think hard about fiscal policies and structural measures to support sustained and adequate aggregate demand.

The threat of secular stagnation has not gone away

May 6th, 2018

The economy is prone to sluggish growth — if the past few years are anything to go by

May 6, 2018

Unemployment in the US is below 4 per cent and growth in the economy is accelerating. By recent standards growth in Europe and Japan is also strong. In these circumstances many believe the idea of secular stagnation can be written off.

Certainly if the phenomenon is defined as the fatalistic view that the economies of the industrialised world are condemned to suffer permanent stagnation with high unemployment, then we are obviously not in a moment of secular stagnation.

However, this is not what Alvin Hansen intended when he coined the phrase, nor what I had in mind when I sought to revive the concept in 2013. Rather the idea of secular stagnation is that the private economy — unless stimulated by extraordinary public actions especially monetary and fiscal policies and, or, unsustainable private sector borrowing —will be prone to sluggish growth caused by insufficient demand.

On this interpretation, the past few years have confirmed the hypothesis.

In the US the Congressional Budget Office forecast, which is comfortably in the mainstream, calls for annual growth of 2.5 per cent over the next three years with growth of 3.3 per cent during 2018. But what is necessary to support this growth? As far as fiscal policy is concerned, the CBO projects growth in actual budget deficits of more than 1 per cent of gross domestic product in 2017-2019, with substantial further increases over time and the most rapid increase in the debt-to-GDP ratio during peak business cycle times than has ever been seen in peacetime.

In terms of monetary policy, indexed bond markets imply that real interest rates will be kept well below 1 per cent for the next 30 years. Meanwhile the economy has been supported by a stock market that has returned 22 per cent in 2017 and an average of 16 per cent over the past five years. This while private sector debt has grown relative to GDP.

If budget deficits had been at normal levels and not growing relative to the economy, real long-term interest rates had been steady in their customary range above 2 per cent and an extra $10tn in wealth had not been created by abnormal stock market returns, it is hard to believe that the US economy would be growing much at all. And it is almost inconceivable that it would be near its 2 per cent inflation target.

Elsewhere in the industrial world Japan’s economy is supported by a government debt-to-GDP ratio that hovers around 250 per cent and long-term real rates of less than minus 1 per cent. Europe has seen a reduction in the ratio of government debt to GDP in recent years but like Japan has received extraordinary stimulus from sub minus 1 per cent real interest rates and increases in the flow of private sector credit. Even with this stimulus Europe and Japan have struggled to achieve 2 per cent inflation.

What we are seeing is the achievement of fairly ordinary growth with extraordinary policy and financial conditions. Something similar took place in the years before the Great Recession.

Whether this is sustainable depends on several factors, not least whether private sector demand will autonomously increase as the financial crisis recedes so growth can be maintained with less unorthodox policy and exuberant financial conditions. Perhaps it can, but it is more likely that a combination of rising inequality, slow labour force and productivity growth, and greater competition from developing countries will keep private sector demand subdued.

There is also a question over whether the current policy mix and financial conditions can be maintained indefinitely. This is doubtful for fiscal policy especially in the US. Monetary policies involving low or negative real interest rates may be sustainable over the long term but they are likely to encourage financial risk, unsound lending and asset bubbles with potentially serious implications for medium-term stability.

The greatest concern remains over whether the next downturn can be handled. Traditionally the response to recession in the industrial world has been fiscal expansion and a 500 basis point cut in interest rates. But the fiscal cannon has already been fired in much of the industrial world leaving policymakers short on ammunition.

So secular stagnation as an issue remains very much alive. Current palliatives are appropriate but unlikely to be long-term solutions. The industrial world can hope that investment demands increase and saving needs decline. But policymakers must turn their attention to demand as well as supply issues going forward.

Secular Stagnation – a prolonged period in which satisfactory growth can only be achieved by unsustainable financial conditions –may be the defining macro-economic challenge of our times. The concept of “Secular Stagnation” originally formulated by the eminent Depression-era economist Alvin Hansen, has experienced a revival since my November 2013 speech on the topic.

June 7th, 2017

Secular stagnation even truer today

June 1st, 2017

This article was originally published by the Wall Street Journal on May 25, 2017.

Larry Summers is doubling down on his secular-stagnation hypothesis.

The Harvard economist and former Treasury secretary first offered the bleak diagnosis in November 2013 at an International Monetary Fund conference. The U.S. and much of the rest of the world was suffering from a chronic shortage of demand and profitable investment opportunities, he argued. There wasn’t any interest rate that would produce healthy growth (given that rates can’t go much below zero).

At a recent academic conference at the Federal Reserve Bank of San Francisco, I asked Mr. Summers how his secular stagnation hypothesis looks today, three and half years after he inserted a Depression-era phrase into today’s debate about the economic outlook. Many economists have had their doubts about his gloomy hypothesis, and not all has gone wrong with the U.S. economy. Unemployment, for example, has fallen to 4.4% from 7.2% in 2013, leading to a rise in wages.


Secular Stagnation in the Open Economy

April 28th, 2016

In an NBER working paper issued in April 2016, Secular Stagnation in the Open Economy, Gauti B. Eggertsson, Neil R. Mehrotra and Lawrence H. Summers look at conditions of secular stagnation – low interest rates, below target inflation, and sluggish output growth – that now characterize much of the global economy. They consider a simple two-country textbook model to examine how capital markets transmit secular stagnation and to study policy externalities across countries. They find capital flows transmit recessions in a world with low interest rates and that policies that trigger current account surpluses are beggar-thy-neighbor. Monetary expansion cannot eliminate a secular stagnation and may have beggar-thy-neighbor effects, while sufficiently large fiscal interventions can eliminate a secular stagnation and carry positive externalities.

2016 Homer Jones Memorial Lecture, “Secular Stagnation and Monetary Policy”

April 6th, 2016

St. Louis Fed President James Bullard welcomed attendees to the annual lecture and introduced this year’s speaker, Lawrence H. Summers, one of the country’s most influential economists and policymakers.

Dr. Summers has helped steer the United States through national and international financial crises over the past two decades. He did so while serving as director of the National Economic Council (Obama administration), as secretary of the U.S. Department of the Treasury (Clinton administration) and as chief economist at the World Bank.

Summers is president emeritus and a distinguished professor at Harvard University, and he directs the university’s Mossavar-Rahmani Center for Business and Government.

The St. Louis Fed’s annual Homer Jones Memorial Lecture honors those who exemplify the highest qualities of leadership in economics and public policy. Jones (1906-1986) was a longtime research director at the St. Louis Fed, playing a major role in developing the St. Louis Fed as a leader in monetary research and statistics.

Increasingly Convinced of the Secular Stagnation Hypothesis

February 17th, 2016

Foreign Affairs has just published my latest on the secular stagnation hypothesis.  I am increasingly convinced that it captures what is going on in the industrialized world and that the risks of long term weakness on the current policy path are growing.

Unfortunately since I put forward the argument in late 2013, the data have been all too supportive.  Despite monetary policy being much more expansionary than was expected and medium term interest rates falling rapidly, growth and inflation throughout the industrial world have been much lower than anticipated.  This is exactly what one would expect if structural factors were increasing saving propensities relative to investment propensities.

Bond markets are now saying that neither inflation rates approaching 2 percent targets or real interest rates substantially above zero are on the horizon anytime in the foreseeable future.  Growth forecasts are being revised downwards in most places and there is growing evidence in the United States that inflation expectations are becoming unanchored to the downside.

I would put the odds of a US recession at about 1/3 over the next year and at over ½ over the next 2 years.   There is a substantial chance that widening credit spreads, a strengthening dollar as Europe and Japan plunge more deeply into the world of negative rates, and lower inflation expectations will be tightening financial conditions even as recession looms.  And while there is certainly scope for QE, for forward guidance and possibly for negative rates it is very unlikely that the Fed can take steps that are nearly the functional equivalent of 400 basis point cut in Fed funds that is normally necessary to respond to an incipient recession.

If I am right in these judgements, monetary policy should now be focused on avoiding an economic slowdown and preparations should be starting with respect to the rapid application of fiscal policy.  The focus of global coordination should shift from clichés about structural reform and budget consolidation to assuring an adequate level of global demand.   And policymakers should be considering the radical steps that may be necessary if the US or global economy goes into recession.

Of course, real time economic theorizing is problematic and I cannot be certain that I am reading the current situation accurately.  If the Fed succeeds in significantly raising rates over the next two years without a growth slowdown and if inflation accelerates to 2 percent, I will conclude that the secular stagnation hypothesis was overly alarmist in confusing cyclical elements with long term problems.  If on the other hand, the economy turns down even at current interest rates, secular stagnation will have to be taken more seriously by policymakers than is currently the case.



The Age of Secular Stagnation

February 17th, 2016

Summers published an article title, “The Age of Secular Stagnation: What It Is and What to Do About It,” in the February issue of Foreign Affairs.  The article explores how expansionary fiscal policy by the U.S. government can help overcome secular stagnation problems and get growth back on track. (more…)

My views and the Fed’s views on secular stagnation

December 22nd, 2015

It has been two years since I resurrected Alvin Hansen’s secular stagnation idea and suggested its relevance to current conditions in the industrial world.  Unfortunately experience since that time has tended to confirm the secular stagnation hypothesis.  Secular stagnation is a possibility.  It is not an inevitability and it can be avoided with strong policy.  Unfortunately, the Fed and other policy setters remain committed to traditional paradigms and so are acting in ways that make secular stagnation more likely.

The core idea behind secular stagnation was that the neutral real rate had for a variety of reasons fallen and might well be below zero a substantial part of the time going forward.  The inference was that economies might be doomed to oscillate between sluggish growth and growth like that of the 2003-2007 period that rested on an unstable financial foundation.

In more technical economic language secular stagnation is the hypothesis that the IS curve has shifted back and down so that the real interest rate consistent with full employment has declined.  More straightforwardly if you see weaker growth despite lower real interest rates that tends to confirm the secular stagnation idea.

The table below shows what has happened since the Fall of 2013 in the industrial world.  Growth has been consistently weaker than was expected.  This has occurred even though interest rates have fallen substantially suggesting that it reflects a reduction in demand.  Further evidence comes from the decline in inflation expectations.  If the dominant shock were slower productivity one might expect to see an increase in inflation.  Whatever risk one saw of secular stagnation two years ago, one has to be more concerned today.

graph for secular stagnation blog posting 122215










Here is a transcript of a lecture (along with the associated power point) given at the Bank of Chile Research Conference that updates my thinking on secular stagnation.  A central argument I make is that even in the United States it is unlikely that we have left the zero lower bound behind.  Indeed I would judge that there is at least a two-thirds chance that we will experience zero or negative rates again in the next five years.

This pessimism is strongly confirmed by the landmark Rachel and Smith study which shows that there is little basis for believing that neutral real rates will rise in the next few years.

To its credit, judging by the “dots” embodying long run rate projections as well as Chair Yellen’s press conference, the Fed has started to recognize the idea of a declining neutral real rate.  Yet I believe its decision to raise rates last week reflected four consequential misjudgments.

First, the Fed assigns a much greater chance that we will reach 2 percent core inflation than is suggested by most available data.  Inflation swaps suggest inflation on the Fed’s preferred PCE deflator measure will average only 1 percent over the next 3 years, 1.2 percent over the next 5 years and 1.5 percent over the next 10 years.  Survey measures of expected inflation are falling not rising.  Moreover, if account is taken of quality change inflation measures would have to be further reduced.

Second, the Fed seems to mistakenly regard 2 percent inflation as a ceiling not a target.  One can reasonably argue that after years of below target inflation, it is appropriate to have a period of above target inflation.  This is implied by arguments for price level targeting.  Alternatively, it seems reasonable to simply suggest that the Fed should run equal risks of over and under shooting its inflation target.  I would actually argue given the observed costs of deflation that the costs of under shooting the target exceed the costs of overshooting it.

Third, the Fed seems to be in the thrall of notions that might be right but do not to my knowledge have analytic support premised on the idea that the rate of change of interest rates as distinct from their level influences aggregate demand.  It is suggested that by raising rates the Fed gives itself room to lower them.  This is tautologically true but I know of no model in which demand will be stronger in say 2018 if rates rise and then fall than if they are kept constant at zero.  Nor conditional on their reaching say 3 percent at the end of 2017 do I know of a reason why recession is more likely if the changes are backloaded.  I would say the argument that the Fed should raise rates so as to have room to lower them is in the category with the argument that I should starve myself in order to have the pleasure of relieving my hunger pangs.

Fourth, the Fed is likely underestimating secular stagnation.  It is failing to recognize its transmission from the rest of the world and it is overestimating the degree of monetary accommodation now present and likely to be present in the future by overestimating the neutral rate.  I suspect that if nominal interest rates were 3 percent and inflation were far below target there would be much less pressure to raise them than there has been of late.  The desire to raise rates reflects less some rigorous Philips curve analysis than a sense that zero rates are a sign of pathology and an economy creating 200,000 jobs a month is not diseased.  The complexity is that zero rates may be less abnormal than is supposed because of fundamental shifts in the saving investment balance,

Why is the Fed making these mistakes if indeed they are mistakes? It is not because its leaders are not thoughtful or open minded or concerned with growth and employment.  Rather I suspect it is because of an excessive commitment to existing models and modes of thought.  Usually it takes disaster to shatter orthodoxy.  We can all hope that either my worries prove misplaced or the Fed shows itself to be less in the thrall of orthodoxy than it has been of late.


Low Real Rates, Secular Stagnation & the Future of Stabilization Policy

November 20th, 2015

On November 20, 2015 at the Bank of Chile Research Conference, Summers updated his thinking on secular stagnation in a speech titled, “Low Real Rates, Secular Stagnation and the Future of Stabilization Policy.

Read the transcript of the lecture and view the powerpoint slides here:

Larry Summers Central Bank of Chile

Where Paul Krugman and I differ on secular stagnation and demand

November 2nd, 2015

Paul Krugman suggests that I have had some kind of change of heart on secular stagnation and converged towards his point of view, citing the publication of the transcript of a 2011 debate which we both participated in. I certainly appreciate the gravity of the secular stagnation issue more than I did a few years ago, given the continuing decline in global real interest rates. But I think Paul exaggerates the change in my views considerably.

The topic of the debate was: “North America faces a Japan-style era of high unemployment and low growth.” Paul argued in favor. I opposed the motion – not on the grounds that the US economy was in good shape, but on the grounds that our demand deficiency problems should be easier to solve than Japan’s.

Quoting from my response to Paul’s arguments:

You’re right the United States has a serious demand deficiency. You’re right that not enough is being done to contain that demand deficiency. You’re right that we will suffer needless unemployment and stagnation until more is done to address that demand deficiency….

My thesis is that as serious as that problem is, it is dimensionally much less than the problems that Japan faced in four respects. Japan’s problems were different in magnitude, different in the depth of their structural roots, different in the relative perspective they had — relative to the rest of the world — and different in the degree of resilience their system had for adapting to them…

…It will take time. There are steps that need to be taken but we are a society that works. We are a society whose principal problems — we all up here agree — can be addressed by a change in the printing of money and the creation of infrastructure.”

Paul responded in part by saying:

The question is, are we going to be stuck in a state of depressed demand of the kind that Larry has talked about. Larry and I agree that that is what has been happening… I think Larry and I agree almost entirely on the economics, on what needs to be done”.

(Full transcript available here).

I think we have both been focused on demand and the liquidity trap for a long time.

There are, though, two areas where I have had somewhat different views from Paul. I believe that structural issues are often important for demand and growth. I have often asserted that “business confidence is the cheapest form of stimulus”, and quoted to President Obama Keynes’ famous 1938 letter to Roosevelt:

“Businessmen … are … at the same time allured and terrified by the glare of publicity, easily persuaded to be ‘patriots’, perplexed, bemused, indeed terrified, yet only too anxious to take a cheerful view, vain perhaps but very unsure of themselves, pathetically responsive to a kind word. You could do anything you liked with them, if you would treat them (even the big ones), not as wolves or tigers, but as domestic animals by nature, even though they have been badly brought up and not trained as you would wish… If you work them into the surly, obstinate, terrified mood, of which domestic animals, wrongly handled, are so capable, the nation’s burdens will not get carried to market; and in the end public opinion will veer their way.”

Second, I have never related well to Paul’s celebrated liquidity trap analysis. It has always seemed to me be a classic example of economists’ tendency to “assume a can opener”. Paul studies an economy in liquidity trap that will, by deus ex machina, be lifted out at some point in the future. He makes the point that if you assume sufficiently inflationary policy after this point, you can drive ex ante real rates down enough to stimulate the economy even before the deus ex machina moment.

This is true and an important insight. But it seems to elide the main issue. Where is the deus ex machina? Where is the can opener? The essence of the secular stagnation and hysteresis ideas that I have been pushing is that there is no assurance that capitalist economies, when plunged into downturn, will over any interval revert to what had been normal. Understanding this phenomenon and responding to it seems the central challenge for macroeconomics in this era.

Any analysis that assumes restoration of previous equilibrium is, from this perspective, missing the main issue.  I was glad to see Paul recognize this point recently.  I suspect it will lead to more emphasis on fiscal rather than monetary actions in depressed economies.


Rethinking Secular Stagnation After Seventeen Months

April 16th, 2015

IMF Rethinking Macro III Conference

I am glad to be here and I salute Olivier (Blanchard) and the IMF for so open a dialogue on so wide a range of macroeconomic hypotheses. What I want to do this morning is talk about three things: I want to tell you why I think that the risk of secular stagnation is an important problem throughout the developed world. I want to contrast the secular stagnation viewpoint with two views that I regard as heavily overlapping – the debt super‐cycle view that Ken Rogoff put forward and the savings glut view that Ben Bernanke has put forward – and explain why I think they’re very similar, but insofar as their nuances of difference, I prefer the secular stagnation view. And then I want to reflect on the policy implications of this general view of the global economy over the next decade. (more…)

On Secular Stagnation: A Response to Bernanke

April 1st, 2015

Ben Bernanke has inaugurated his blog with a set of thoughtful observations on the determinants of real interest rates (see his post here) and the secular stagnation hypothesis that I have invoked in an effort to understand recent macroeconomic developments.  I agree with much of what Ben writes and would highlight in particular his recognition that the Fed is in a sense a follower rather than a leader with respect to real interest rates –  since they are determined by broad factors bearing on the supply and demand for capital – and his recognition that equilibrium real rates appear to have been trending downward for quite some time.  His challenges to the secular stagnation hypothesis have helped me clarify my thinking and provide an opportunity to address a number of points where I think there has been some confusion in the public debate. (more…)

Reflections on Secular Stagnation

February 25th, 2015

Summers gave the keynote address at Princeton University’s Julius-Rabinowitz Center for Public Policy & Finance on February 19, 2015. In his remarks, Summers gave his perspective on the “profound macroeconomic challenge of the next 20 years in the industrial world: secular stagnation.” (more…)

Response to Marc Andreessen on Secular Stagnation

January 12th, 2015

Marc Andreessen’s thoughtful “Tweetstorm” on secular stagnation raises a number of important questions.  We are in agreement that the essence of the secular stagnation issue is not whether technology has stopped advancing; but rather whether there is a mismatch between desired saving and investment opportunities that results in low equilibrium real interest rates, precipitates financial instability, and may inhibit economic growth. Here I respond to his specific questions and criticisms regarding the secular stagnation hypothesis: (more…)

Bold reform is the only answer to secular stagnation

September 8th, 2014

September 8, 2014

There may be supply-side barriers that hold the economy back before constraints on demand bind

By Lawrence H. Summers

The economy continues to operate way below any estimate of its potential made before the onset of financial crisis in 2007, with a shortfall of gross domestic product relative to previous trend in excess of $1.5tn, or $20,000 per family of four. As disturbing, the average growth rate of the economy of less than 2 per cent since that time has caused output to fall further and further below previous estimates of its potential.

Almost a year ago I invoked the concept of secular stagnation in response to the observation that five years after financial haemorrhaging had been staunched, the business cycle was cycling back to what had been previously thought of as normal levels of output.

Secular stagnation in my version, like that of Alvin Hansen, the economist who coined the term in the 1930s, has emphasised the difficulty of maintaining sufficient demand to permit normal levels of output.

But with a high propensity to save, a low propensity to invest and low inflation, this has been impossible. Nominal interest rates cannot fall below zero, as they would have to for real interest rates to be low enough to enable saving and investment to be equated with the economy producing at its full potential. Furthermore, even if potential output can be attained, it would require interest rates so low that they risk financial instability.

Given the factors operating to reduce natural interest rates – rising inequality, lower capital costs, slowing population growth, foreign reserve accumulation, and greater costs of financial intermediation – it seems unlikely that the American economy is capable of demanding 10 per cent more output than it does now, at interest rates consistent with financial stability. So demand-side secular stagnation remains an important economic problem.

But, as the work of Robert J Gordon has shown, there may now be supply-side barriers that threaten to hold back the economy before constraints on the ability to create demand start to bind. Two ways of looking at the current situation point up the difficulty.
First, while I have emphasised that levels of GDP are far short of what pre-crisis trends would predict, the unemployment rate at 6.1 per cent (down from a 10 per cent peak) has reverted most of the way back to even relatively optimistic estimates of its normal level. In other words, even while economic growth performance has been very poor, it appears that demand has been advancing rapidly enough to substantially reduce slack in the labour market. Weak growth, along with substantial decreases in slack, suggests significant weakness in the growth of potential output.

To be fair, there is room to cavil about the unemployment rate as a measure of slack in the labour market. But the extent of apparent normalisation is even greater if one looks at measures of job openings and vacancies, new unemployment insurance claims, or the short-term unemployment rate.

Second, with Friday’s relatively weak employment statistics job growth has averaged 200,000 jobs a month over the past six months. If this continues, what would it imply for movements in the unemployment rate?

This depends on what happens to labour force participation, which has been trending downwards because of population ageing and long-term structural trends, even as the unemployment rate has declined sharply. Assume (optimistically, given recent trends) that the labour force participation rate for workers of a given age remains constant, and that the economy creates 200,000 jobs a month. The unemployment rate would then fall to about 4 per cent by the end of 2016.

While such a low unemployment rate is conceivable, it seems much more likely that employment growth would slow at some point, because of rising wage costs or policy actions, or because employers have difficulty finding workers. Then, the economy would be held back not by lack of demand but lack of supply potential.

Why has the economy’s supply potential declined so much relative to the pre-2007 trend? This will be debated in the years to come. Part of the answer lies in the damaging effect of past economic weakness on future potential. Part is the brutal demographics of an ageing population, the end of the trend towards increased women’s labour force participation, and the exhaustion of the gains from an increasingly educated workforce. And part is the apparent slowing of at least measured productivity.

To achieve growth of even 2 per cent over the next decade, active support for demand will be necessary but not sufficient. Structural reform is essential to increase the productivity of both workers and capital, and to increase growth in the number of people able and willing to work productively. Infrastructure investment, immigration reform, policies to promote family-friendly work, support for exploitation of energy resources, and business tax reform become ever more important policy imperatives.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary.

NYTimes: Europe is at risk of secular stagnation

August 30th, 2014

In a front page, New York Times story on August 30, 2014, Summer’s says, “Europe is at risk of secular stagnation.”  He added, “There is little chance that reasonable and rapid growth is going to return to the Eurozone.”  The article concluded, “A greatly diminished Europe will mean that the US will increasingly lack its best partners.” (more…)

Secular Stagnation: facts, causes and cures

August 28th, 2014

Summers contributed a chapter, “Reflections on the New Secular Stagnation Hypothesis,” to the new Vox eBook, “Secular Stagnation: facts, causes and cures.” (more…)

Secular Stagnation Q&A in The New Republic

July 29th, 2014

In a July 2014 interview with the New Republic, Summers discusses secular stagnation and says, the economy hasn’t grown rapidly “in a financially sustainable way” for a long time. (more…)