The Keynesian Excuse: Secular Stagnation

Lawrence Summers photo

Lawrence H Summers, leading Keynesian resurrecting Secular Stagnation
Photo Credit: Wikimedia Commons/LHSummers

The Keynesians must be panicking. In the United States, Europe, and Japan, nothing they have advised governments to do seems to be working very well. GDP growth rates throughout the economically developed world are stagnating, and Keynesian stimulus and monetary policies, particularly Quantitative Easing (QE), are not producing growth. Instead of being stimulative and slightly inflationary as expected, QE has turned out to be not at all stimulative and at least moderately deflationary. What is a good Keynesian supposed to do in a situation like this?    

The distinguished Keynesian economist Larry Summers, collaborating with other Keynesians, is working to dust off the old Keynesian doctrine of Secular Stagnation in order to explain Keynesian theory’s bad results. Summer’s collaborators include Barry Eichengreen, Robert J. Gordon, Paul Krugman, Edward L. Glaesser, Joel Mokyr, Nicholas Crafts, Olivier Blanchard, Davide Forcer, Andrea Pescatori,  Ricardo J. Caballero, Emanuel Farhi, Gauti B. Eggertson, Neil Mehrotra, Richard C. Koo, Guntram B. Wolff, Juan F. Jimena, Frank Smets, and Jonathon Yiangou. Together they have produced an ebook on secular stagnation, which you can obtain for free in PDF form here, or you can obtain it in Kindle ebook format here for a price.

Keynesian Need for Secular Stagnation

The idea of secular stagnation was originated by the Keynesian economist Alvin Hansen in 1937 to explain why the New Deal programs were not working to produce economic growth. The basic idea was that businesses and investors had run out of useful ways to put their assets to work to produce economic growth. The word secular in the phrase “secular stagnation” is used to indicate the stagnation is long-term as opposed to  cyclical. Once economic growth took off in the 1950s, secular stagnation was forgotten until soon after the end of the Great Recession. Currently, with a lot of egg on their faces from the failures of their ideas, Keynesians find it necessary to revive the idea.

In the opening chapter of their ebook, Summers writes,

The ‘new secular stagnation hypothesis’ responds to recent experience and the manifest inadequacy of conventional formulations by raising the possibility that it may be impossible for an economy to achieve full employment, satisfactory growth, and financial stability simultaneously simply through the operation of conventional monetary policy. It thus provides a possible explanation for the dismal pace of recovery in the industrial world, and also for the emergence of financial stability problems as an increasingly salient concern.

A little later in the chapter, he notes

It has now been more than five years since the US economy reached its trough in the second quarter of 2009, and close to five years since evidence of systemic financial risk – as reflected in LIBOR spreads, the need for government bailouts, or elevated risk premiums on bank debt – has been pervasive. Yet US economic growth has averaged only 2% over the last 5 years, despite having started from a highly depressed state. In a similar vein, credit spreads in Europe have come way down and fears of the dissolution of the Eurozone have been sidelined, yet growth has been glacial over the past several years and is not expected to rapidly accelerate.

Therefore, Keynesians are greatly in need of an explanation (some would unkindly say an excuse) for why Keynesian ideas have not worked. Using secular stagnation as that explanation allows Keynesians to say that all the fault lies in the rigidities of the economy and society. Engineering a more ingenious way for government to intervene in the mechanics of the system in their view still holds out the promise of higher economic growth, employment, and wages.

Keynesian Explanations for Secular Stagnation

What makes a Keynesian explanation of our current stagnation different from a more neoclassical or New Classical one is that the causes are taken to be endemic in the economic system or non-governmental aspects of society. Note that causes rooted in government policies are not considered. Nevertheless, with society and modern economies so complicated, anyone can imagine any number of reasons for stagnating growth that do not involve (or at least do not seem to involve) governmental causes. Here is a partial list suggested by Alvin Hanson, Larry Summers, and his compatriots.

  • Society ceases to produce technological innovation at the rate required to produce new economic opportunities.
  • The economy already has excess capacity, and more investment will not lead to increased profits for companies.
  • The damage caused by the preceding recession/depression was so great, long-lasting, and permanent that many workers have permanently left the labor market and will never work again.
  • An advanced economy is now paying the price for years of inadequate investment in infrastructure and education. This gives corporations an inadequate supply of trained labor to grow and inadequate infrastructure (for transportation, urban security, etc.)
  • We have not had healthy economic growth in over 20 years with a lack of productive investment avenues hidden by the dot-com bubble, and the real estate bubble that popped in the 2007-2008 financial crisis. Now that these bubbles have burst, companies have few if any economically productive ways to invest.
  • The demographics of the developed world are working against it. There is an increasing number of  older, retired people being supported by a diminishing number of working, younger people. The still productive younger folks must be taxed at higher rates to support the retired, leaving a smaller amount of capital available for investments.

Any mechanism that results in some companies not finding new ways to invest means there can be no new net investment by these companies to increase the total factor productivity, which is the only way in which a mature economy can grow. From the macroeconomic Solow-Swan growth model we learn that the only way to grow from a steady-state economy is to increase factors of productivity other than the amount of available capital and labor. These other factors of productivity usually involve investment in technology or labor training to provide new or better products, or more efficient ways of producing old products. All of these other productivity factors are conventionally gathered into a function called “total factor productivity”. Read the posts The Solow-Swan Model and Where We Are Economically (1), The Solow-Swan Model and Where We Are Economically (2), and The Solow-Swan Model and Where We Are Economically (3) for a relatively painless tutorial on the Solow-Swan model and its importance. The very last post in the series has the material explaining how new growth comes from an increase in the total factor productivity, but the first two are needed to understand the third.

Solutions suggested by Keynesians uniformly require some extensive and long-term government intervention into the economy’s mechanics. Such solutions include suggestions such as keeping monetary policy very loose for a longer period of time to generate inflation, which from the Keynesian point-of-view will produce increased employment and economic output. It also conceivably could include encouraging an increase in the age of retirement, and more extensive government labor training programs to increase the quantity and quality of the labor force, thereby lessening the problem of demographics.

Why We Should Not Use the Keynesian Ideas on Secular Stagnation

So why should we not think seriously about these plausible explanations and act upon them? Every time the government intervenes deeply into the economy, it is like setting a wild bull free in a shop of extremely delicate china, with the china being the many millions of supply-demand balances (or lack of balances) that make up the economy. A government regulator or other economic agent ignores these balances to his or her peril (not to mention our peril!). Any imbalance in any of these relationships will end up in economically deleterious surpluses or shortages that will generate unemployment. Although the post Why Socialism Does Not Work was written primarily with a socialist economic system in mind, the effects of state intervention on the economy in a mixed economy could be described in almost an identical way, word-for-word.

I will continue this discussion in my next post, What to Do About Keynesian Secular Stagnation.

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