Big ideas of 2014: Secular stagnation—does monetary policy need a radical rethink?

The global economy might have been in trouble long before 2008
December 12, 2013

“What if the downturn is an effect of persistent economic stagnation?”: Former US Treasury Secretary Larry Summers © AP Photo/Michel Euler

Larry Summers, the former US Treasury Secretary, captured one of 2014’s big themes in two words—”secular stagnation”—in a speech to the International Monetary Fund in November. The idea isn’t new—its roots are in the 1930s—but his interjection, just as growth is picking up, provoked a storm of comment.

What if, Summers asked, it turns out that the downturn which followed the crisis of 2008 is an effect of persistent or “secular” economic stagnation? And what if the financial excesses that led to the crash in the first place were themselves a response to structural weaknesses in the developed economies? That might mean that the only way for central banks to boost demand was to create a succession of asset price bubbles (technology stocks in the late 1990s, housing in the middle of the last decade)?

Summers, and those who promptly sided with him, including the Nobel laureate Paul Krugman, were not denying signs of recovery. The US economy grew by 2.5 per cent in the second quarter of 2013, and 2.8 per cent between July and September; Britain achieved 0.7 per cent and 0.8 per cent in those periods. Yet if this is a recovery, it is weak. Britain’s growth between July and September is 2.5 percentage points below the pre-recession high of the first quarter of 2008.

Kenneth Rogoff, the Harvard economist and historian of banking crises, disagrees. He has argued that “the evidence… seems overwhelming that the drag on the global economy mainly reflects the aftermath of a deep systemic financial crisis.” If, as he suggests, this crisis resembles earlier ones, then the usual remedies of fiscal and monetary policy should start to have a decisive effect.

Summers, in contrast, insists that our problems did not all start with the post-crisis recession. The economist Gavyn Davies says: “Larry has stirred up a major debate with his comments. His suggestion that the global economy has been grappling with a problem of excess savings and under-confidence for well over a decade raises some very profound questions about monetary, fiscal and exchange rate policy in the US and the rest of the world. The next stage is to start to suggest some solutions, which may well focus on public infrastructure and education expenditure, rather than on monetary policy.”

Summers’s analysis—and vocabulary—were not original; he borrowed the term “secular stagnation” from Alvin Hansen, who coined it in the 1930s, in the wake of the Great Depression. They also echoed what the American economist Tyler Cowen has written about the “great stagnation” afflicting the US economy, which he attributes to a combination of stalled technological progress and faltering innovation. Cowen told Prospect: “In the US and UK we have seen plenty of signs of longer-term economic stagnation, most of all in wages and employment. But our demand-side problems [as described by Summers] are a symptom of these developments, not a cause of them.”

Robert Gordon, who teaches economics at Northwestern, has offered a similar account, arguing that US growth has been slowing down since the middle of the 20th century, and that this reflects a secular stagnation in technology and innovation. His thesis is controversial, of course, as are Cowen’s and Summers’s. But, as Rogoff has conceded, even if the “economic trauma of the last few years reflects, first and foremost, a financial meltdown… the way forward must simultaneously treat other obstacles to long-term growth.” Taking Summers and the others seriously will help policymakers to figure out what those obstacles might be.

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