Book Review: Secular Stagnation: Facts, Causes Too Cures

The Centre for Economic Policy Research (CEPR) has lately published the costless eBook "Secular Stagnation: Facts, Causes as well as Cures" (edited by Coen Teulings as well as Richard Baldwin), which is a serial of thirteen articles yesteryear prominent economists on the topic of secular stagnation, along with a summary yesteryear the editors. (It is also available at Amazon for the Kindle, but it is non costless inward that format.) This review volition human activity every bit a brief summary of some of the articles, along with some high degree comments. I am currently writing a sequence of articles on "slow growth", as well as I volition address some of the topics inside the eBook at a afterward appointment inward to a greater extent than detail.

Contents

The articles inside the eBook are divided yesteryear theme, as well as are every bit follows.

• Introduction Coen Teulings as well as Richard Baldwin

Opening the debate

• Reflections on the ‘New Secular Stagnation Hypothesis’ Laurence H Summers

Three issues: Potential growth, effective demand, as well as sclerosis

• Secular stagnation: H5N1 review of the issues Barry Eichengreen
• The turtle’s progress: Secular stagnation meets the headwinds Robert J Gordon
• Four observations on secular stagnation Paul Krugman
• Secular joblessness Edward L Glaeser

Further on potential growth

• Secular stagnation? Not inward your life Joel Mokyr
• Secular stagnation: U.S. hypochondria, European disease? Nicholas Crafts

Further on effective demand

• A prolonged flow of depression existent involvement rates? Olivier Blanchard, Davide Furceri as well as Andrea Pescatori
• On the role of condom property shortages inward secular stagnation Ricardo J Caballero as well as Emmanuel Farhi
• A model of secular stagnation Gauti B. Eggertsson as well as Neil Mehrotra
• Balance canvass recession is the ground for secular stagnation Richard C Koo
• Monetary policy cannot solve secular stagnation alone Guntram B Wolff

Further on sclerosis

• Secular stagnation: H5N1 thought from the Eurozone Juan F. Jimeno, Frank Smets as well as Jonathan Yiangou

Secular Stagnation: Background

The term secular stagnation was associated with the economist Alvin Hansen, which gained prominence inward his 1938 Presidential spoken communication to the American Economics Association - "Economic Progress as well as Declining Population Growth". The strong economical growth that started inward conjunction with the Second World as well as inward the next decades led to stagnation theories dropping out of sight. Larry Summers brought the thought dorsum inward a 2013 spoken communication to the International Monetary Fund forum.

The usage of the term "secular stagnation" was marketing genius on Larry Summers' part. People had been writing nearly how this bike was sluggish for some time; secular stagnation acts every bit a catchy summary phrase. But, every bit Barry Eichengreen observes,

But patch the term ‘secular stagnation’ was widely repeated, it was non widely understood. Secular stagnation, nosotros receive got learned, is an economist’s Rorschach Test. It way dissimilar things to dissimilar people.

Additionally, it is non especially new, as I argued inward an before essay,  It turns out that Larry Summers (amongst others) shares that assessment:

Imagine that U.S. credit standards had been maintained, that housing had non turned into a bubble, as well as that financial as well as monetary policy had non been simulative. In all likelihood, output growth would receive got been patch inadequate because of an insufficiency of demand. Prior to 2003, the economic scheme was inward the throes of the 2001 downturn, as well as prior to that it was beingness driven yesteryear the meshing as well as stock marketplace bubbles of the belatedly 1990s. So it has been or so twenty years since the American economic scheme grew at a good for you lot footstep supported yesteryear sustainable finance.

Given that many marketplace commentators as well as participants tend to only facial expression a few months ahead at a time, a swell many people volition live on ready to proclaim "secular stagnation is dead" if the USA manages to string together a few quarters of strong gross domestic product growth. Although the secular tendency for growth is weak, the concern bike has non been abolished. As a result, such a outburst of growth would non invalidate this interpretation of "secular stagnation" (although it would cast dubiety on some of the formulations, such every bit those that attach importance to the cypher outflow of involvement rates).

Interest Rates

From the perspective of a fixed income analyst, the most of import implication of secular stagnation is the number on the degree of involvement rates. The to a greater extent than oft than non mainstream analysis presented inside the mass argues that secular stagnation implies that the existent charge per unit of measurement of involvement needed to render the economic scheme to total work is negative, which appears impossible to attain given the nominal rigidities inside the economic scheme (resistance to falling wages). The implication is that nosotros volition spending a lot of fourth dimension with nominal rates at the cypher lower bound.

If correct, this would explicate the drib inward frontward rates shown above. In other words, the rally inward bonds is non a "bubble", rather it is a belated catching upward to reality yesteryear the bond market. Although I am sympathetic to this interpretation, I am cautious nearly Treasury valuation. Term premia could really easily reset higher inward the human face of Fed charge per unit of measurement hikes.

I volition hash out hither 2 of the essays that focus heavily on involvement rates.

In Larry Summers' article, he refers to the article "Measuring The Natural Rate of Interest" yesteryear Thomas Laubach as well as John Williams of the San Francisco Fed (link to alphabetic character which discusses the concept of the Natural Rate of interest, which also links to the article). The "natural charge per unit of measurement of interest" is measured yesteryear their methodology yesteryear using a Kalman filter to approximate simultaneously the natural charge per unit of measurement of interest, potential output, as well as the tendency growth charge per unit of measurement of output. The embedded supposition inside this methodology is that deviations of the actual existent Fed Funds charge per unit of measurement from the natural charge per unit of measurement volition final result inward an acceleration of growth. This estimated natural charge per unit of measurement of involvement savage from 4.42% inward 1961 to -0.07% inward 2014 (based on updates published inward a spreadsheet at the FRBSF).

The Krugman newspaper gives a less rigourous way of getting to the same full general conclusion; he looked at average existent Fed Funds rates across the cycle. This has tended lower since the 1980s. Once again, the embedded supposition is that the actual existent Fed Funds charge per unit of measurement cannot markedly deviate from the "natural" existent charge per unit of measurement for an extended flow of time, without causing economical acceleration and/or inflation which nosotros did non observe.

This is most troubling portion of "secular stagnation" for the economical mainstream, which had locomote obsessed with monetary policy (and which assumed financial policy out of existence). And it sure matters for bond investing. However, a non-mainstream viewpoint casts some dubiety upon this assessment.

If the existent economic scheme is non especially sensitive to the existent charge per unit of measurement of interest, as well as then the asymmetric nature of key banking concern reaction functions implies that nominal rates volition eventually crash to cypher during a flow of secular stagnation. What I hateful yesteryear asymmetry is that the key banking concern volition panic as well as cutting rates chop-chop during a financial crisis (and at that topographic point is invariably a financial crisis during a "modern" recession), but the deadening growth during an expansion way that the charge per unit of measurement cuts are non reversed before the adjacent recession hits. Tim Duy, inward "The Methodical Fed"  discusses how this realisation has featured inward recent discussions nearly the render to the cypher outflow when the adjacent recession hits (assuming that rates are indeed hiked before then).

From this betoken of view, depression existent involvement rates are purely an artefact of key banking concern reaction functions, as well as non an inherent belongings of "secular stagnation". Given the moribund nation of modern mainstream macroeconomics, I exercise non catch those reaction functions changing, but I would caution that it is e'er possible.

Financial Instability

It has been known for centuries that investors human activity inward a loopy fashion when confronted with depression nominal involvement rates on authorities bonds. ("'John Bull tin stand upward many things, but he cannot stand upward 2 per cent.'" from Lombard Street yesteryear Bagehot, 1873). This is a clear worry of some of the authors inside the eBook.

Although it is clear that many investors receive got been deranged yesteryear the JGB market, but I receive got some doubts nearly the causality betwixt financial instability as well as depression involvement rates. The 1950s featured depression involvement rates, nonetheless the financial arrangement was stable. Hyman Minsky inward particular discussed the reasons for that stability. However, the 1950s was a special period, as well as it would non live on piece of cake to replicate those weather in i trial again. Correspondingly, the depression involvement charge per unit of measurement surroundings volition coincide with financial instability, but that may merely reverberate the unwillingness to exercise anything useful nearly that instability.

Supply Side Arguments

Robert Gordon looks at the "supply side" storey - potential growth - as well as has a dissimilar viewpoint.

As the U.S. unemployment charge per unit of measurement declines toward the normal degree consistent with steady non-accelerating inflation, yesteryear Definition actual output catches upward to potential output. I have provided (Gordon 2014b) a layman’s guide to the numbers that link the performance of existent gross domestic product as well as the unemployment charge per unit of measurement as well as receive got concluded that U.S. potential existent GDP over the adjacent few years volition grow at only 1.4 to 1.6% per year, a much slower charge per unit of measurement that is built into electrical flow U.S. authorities economical as well as budget projections. My analysis suggests that the gap of actual surgical operation below potential that concerns Summers is currently quite narrow as well as that the deadening growth he observes is to a greater extent than a job of slow potential growth than a remaining gap [emphasis added - BR].

His before analysis that pointed to lower potential growth rates was oft misinterpreted every bit beingness a commentary nearly technology. He emphasises that his thought implies a continuation of the trends that receive got been inward house for nearly forty years.

My forecast of growth over the 25 to forty years is measured from 2007, non from now. The sources of deadening growth exercise non involve technological change, which I assume volition locomote along at a charge per unit of measurement similar to that of the terminal 4 decades. Instead, the beginning of the growth slowdown is a laid of 4 headwinds, already blowing their gale-force to deadening economical progress to that of the turtle. These 4 barriers to growth are demographics, education, inequality, as well as authorities debt. These volition cut back growth for existent gross domestic product per capita from the 2.0% per twelvemonth that prevailed during 1891-2007 to 0.9% per twelvemonth from 2007 to 2032. Growth inward the existent disposable income of the bottom 99% of the income distribution is projected at an fifty-fifty lower 0.2% per year. 

Potential growth rates are oft tied to productivity as well as technology. He argues that the emphasis on the query why productivity growth slowed since the 1970s is incorrect; rather the query is why productivity was high from the 1930s-1970s? Productivity growth both before as well as after that flow is similarly low.

Note that Joel Mokyr takes the opposite thought towards potential growth inside his contribution.

In the aftermath of the Great Recession, many economists are persuaded that deadening growth is hither to stay. This chapter argues that technological progress – especially inward areas such every bit computing, materials, as well as genetic engineering scientific discipline – volition examine the pessimists wrong. The indirect effects of scientific discipline on productivity through the tools it provides scientific enquiry may dwarf the direct effects inward the long run. Although technological advances may polarise labour markets, they also convey widespread benefits that are non accurately reflected inward aggregate statistics.

I hold off to render to this topic inward afterward essays, so I volition offering only a few brief points. As Robert Gordon notes, the decades from the 1930s-1970s were special for growth, but I exercise non yell upward they were the final result of "lucky breaks" (as Gordon puts it), rather the final result of policies that emphasised growth at all costs, especially during World War II. In peacetime, priorities are different. Although productivity trends are non supposed to affected yesteryear the cycle, the long term is a serial of brusk terms, as well as productivity is cyclic. (This cyclical nature of productivity makes its usage inward concern bike models problematic.)

Since the 1970s, policy makers receive got made many changes to the construction of the economic scheme based on the theory that they would address render side issues as well as so increase potential growth. Since growth is slower directly than it was then, I remain skeptical that policy supposedly driven yesteryear render side concerns volition augment growth..

Policy Remedies

Given the number of authors involved, at that topographic point is a large number of policy implications discussed inside the eBook. I volition listing a few that were included inward the summary yesteryear the editors.

• Monetary policy is less effective.  Since rates volition live on stuck at the cypher lower outflow a expert portion of the time, the 1990s consensus that monetary policy tin cure all macro ills is due for a rethink. One possible way of reducing the fourth dimension at the cypher lower outflow is to heighten the target inflation charge per unit of measurement to 4%. Such a policy shift would thing a lot for bond markets, but I exercise non thought such a alter every bit likely. Firstly, a expert portion of the electorate is inflation-phobic, as well as I am unaware of whatsoever pro-inflation major political parties. Secondly, it would live on really hard for key banks to hitting a 4% target. They tin easily maintain inflation or so a 2% inflation yesteryear keeping excess capacity inward the economy. Nominal rigidities volition maintain the inflation charge per unit of measurement slightly positive. Hitting a 4% target would require much stronger command of the economy.
• Fiscal policy looks to a greater extent than important. Richard Koo's essay is the most emphatic on this topic, but other authors directly catch financial policy every bit beingness to a greater extent than of import than they thought earlier.
• Infrastructure investment. The 1960s mainstream "Keynesian" bias towards infrastructure investment is in i trial over again fashionable. I developed a skeptical mental attitude towards infrastructure investment every bit a final result of reading Hyman Minsky. As the Québec authorities discovered the hard way this decade, pretty good all structures (other than the Pyramids) require continued costly maintenance. Launching a badly thought out infrastructure programme is non going to exercise hereafter generations whatsoever favours. And inward the brusk term, infrastructure investment is majuscule intensive, as well as thence it volition create lilliputian work as well as belike exacerbate inequality.  

My betoken of thought on the policy answer is straightforward. Why exercise nosotros attention nearly deadening growth? If I am wearing my fixed income analyst hat, it matters for property marketplace valuation as well as for actuarial assumptions. This is only of involvement to sure people. But for policy makers, deadening growth is worrisome because of the resulting unemployment. This suggests the right policy response: create jobs. This tin live on done via something similar the Modern Monetary Theory "Job Guarantee" programme.

I would debate that financial policy is non an surface area for misdirection as well as subtlety. If you lot desire to accomplish something, exercise it. If you lot demand to win a war, gain a lot of munitions. If you lot need infrastructure, create it. Conversely, edifice infrastructure you lot exercise non actually demand nor intend to maintain properly merely because at that topographic point may live on some collateral task creation along the way is non a sensible policy.

Other Topics

As noted earlier, I am inward the procedure of writing a serial of articles on deadening growth. I hold off that I volition render to some of the concepts discussed inside this eBook at a afterward point. But I volition directly briefly comment on a few miscellaneous topics.

• Edward L Gleaser looks at the labour market, as well as argues that the electrical flow welfare nation may discourage employment. This is an onetime electrical load of Minsky, although updated to electrical flow circumstances. H5N1 policy of direct task creation would take away the problems he observes.
• There are 2 articles discussing the particular problems of the euro zone. I receive got non spent a expert fourth dimension looking at the euro zone economies inward recent years, as well as so I am non every bit good well placed to hash out those essays. 
• Richard Koo discusses "balance canvass recessions" as well as secular stagnation. Since it residuum canvass oriented analysis, it parallels my 2 portion article on stock-flow norms as well as secular stagnation (link to Part 1). If you lot exercise non acquire every bit good deep into theoretical distinctions, at that topographic point is a expert bargain of analysis that sounds similar, every bit they are all related to the thought of "underconsumption". 
• Gauti Eggertsson as well as Neil Mehrotra hash out a overlapping generation (OLG) DSGE model that exhibits the properties of "secular stagnation". This was i of the to a greater extent than theoretical chapters inward the book, but it is presented without mathematical detail.

Concluding Remarks

This eBook provides a readable introduction to the job of deadening growth that is facing the developed economies. Readers who desire to a greater extent than technical details volition demand to facial expression at the academic articles that are summarised therein. Since at that topographic point are a swell many contributors, at that topographic point is a diversity of views expressed. This gives the reader a wider thought of the problem, at the toll of having a less unified narrative.

See Also

• My analysis of secular stagnation using stock-flow norms. (Link to Part 2.)

(c) Brian Romanchuk 2014