Larry Summers: Why stagnation might prove to be the new normal:
Is it possible that the US and other major global economies might not return to full employment and strong growth without the help of unconventional policy support? I raised that notion….
- Even though financial repair had largely taken place four years ago, recovery has only kept up with population growth and normal productivity growth in the US, and has been worse elsewhere in the industrial world.
- Manifestly unsustainable bubbles and loosening of credit standards during the middle of the past decade, along with very easy money, were sufficient to drive only moderate economic growth.
- Short-term interest rates are severely constrained by the zero lower bound: real rates may not… fall far enough to spur enough investment to lead to full employment…
- Falling wages and prices… are likely to… encourag[e]… consumers and investors to delay spending, and to redistribute income and wealth from high-spending debtors to low-spending creditors.
The implication… is… the presumption that normal economic and policy conditions will return at some point cannot be maintained. Look at Japan, where gross domestic product today is less than two-thirds of what most observers predicted a generation ago…. Japanese GDP disappointed less in the five years after the bubbles burst at the end of the 1980s than the US has since 2008….
There are two central issues regarding the secular stagnation thesis that have to be addressed….
- Is not a growth acceleration in the works?… One should also recall that fears of secular stagnation were common at the end of the second world war and were proved wrong…. Secular stagnation should be viewed as a contingency to be insured against–not a fate to which we ought to be resigned. Yet, it should be recalled that the achievement of escape velocity has been around the corner in consensus forecasts for several years….
- Why should the economy not return to normal after the effects of the financial crisis are worked off?… There are many a priori reasons why the level of spending at any given set of interest rates is likely to have declined…. Logic is supported by evidence. For many years now indexed bond yields have been on a downward trend. Indeed, US real rates are substantially negative at a five year horizon.
Some have suggested that a belief in secular stagnation implies the desirability of bubbles to support demand. This idea confuses prediction with recommendation…. Better to support demand by supporting productive investment or highly valued consumption…. The risk of financial instability provides yet another reason why pre-empting structural stagnation is so profoundly important.
Let me make three points:
(1) We have seen the concern of the last paragraph before. In fact, the worry has been slowly building for more than a decade. It was nearly twelve years ago that Paul McCulley and Paul Krugman were worrying about this. And Paul Krugman wrote:
Paul Krugman (2002): Dubya’s Double Dip?:
The recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again…. To fight this recession the Fed needs… soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble…
And, back then, the prospect of only being able to reattain full employment via households that grossly overestimated their real wealth and thus spent well beyond their means was as unappetizing to Paul Krugman and Paul McCulley as it is to Larry Summers now: much better to find a way to reconfigure the macroeconomy so that we are not stuck in a semi-permanent situation in which the only way to reattain anything like full employment is to persuade some group to spend massively more than they really want to. (And, yes, I do have a hard time understanding why a David Henderson or a Lew Rockwell then or a Clive Crook today would misread McCulley, Krugman, and Summers to think that they were welcoming the prospect rather than expressing their unease at it.)
And it was fifteen years ago that Paul Krugman was shocked by the triple crises of Japan 1991-, Mexico 1994-5, and East Asia 1997-8 to write his Return of Depression Economics laying out the case that “liquidity traps” and a need for more than normal expansionary monetary policy to maintain full employment would be much more the rule in the future than they had been in the past. This worry is not simply the Lesser Depression of 2008- casting its shadow into human minds.
(2) The root problem remains a more sophisticated version of what the young John Stuart Mill diagnosed as the disease of capitalist market economies back in 1829, in reaction to the depression that followed the 1825 collapse of the British Canal Bubble:
There can never, it is said, be a want of buyers for all commodities; because whoever offers a commodity for sale, desires to obtain a commodity in exchange for it, and is therefore a buyer by the mere fact of his being a seller. The sellers and the buyers, for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise to each other; and if there be more sellers than buyers of one thing, there must be more buyers than sellers for another.
This argument is evidently founded on the supposition of a state of barter; and, on that supposition, it is perfectly incontestable….
If, however, we suppose that money is used, these propositions cease to be exactly true…. Now the effect of the employment of money, and even the utility of it, is, that it enables… interchange to be divided into two separate acts or operations; one of which may be performed now, and the other a year hence, or whenever it shall be most convenient….
It must, undoubtedly, be admitted that there cannot be an excess of all other commodities, and an excess of money at the same time. But those who have, at periods such as we have described, affirmed that there was an excess of all commodities, never pretended that money was one of these commodities; they held that there was not an excess, but a deficiency of the circulating medium. What they called a general superabundance, was not a superabundance of commodities relatively to commodities, but a superabundance of all commodities relatively to money.
What it amounted to was… persons in general… liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money…. But the result is, that all commodities fall in price, or become unsaleable…
And two things can then happen:
Production and incomes can fall until people are so poor that their desire to hoard–to build up their holdings of “money”–is offset by the fact that their incomes will no longer cover their necessities: money demand will then be low enough to not exceed but match aggregate supply, and by Walras’s Law the demand and supply for currently-produced economies will then be in equilibrium. Or:
Some agency can then print up extra assets that fit business and household definitions of “money”–or something else can happen to diminish money demand at full employment–and full employment and normal levels of capacity utilization will then be restored.
John Stuart Mill believed back in 1829 that such a “general glut” of currently-produced goods and services could not last for long:
This state can be only temporary, and must even be succeeded by a reaction of corresponding violence, since those who have sold without buying will certainly buy at last, and there will then be more buyers than sellers…
Why? Because he did not imagine that there could be a permanent, or even a persistent, elevation of the demand for “money” above its normal level that the market economy could not fix, either via a deflation that raised the real supply of money or via financial intermediaries’ profiting by using the law of large numbers to create safe, liquid, transferable assets that would be seen as close enough to “money” to satisfy the demand.
We do not seem to be so certain. But why not?
(3) The question is: Why aren’t we confident? After all, when it comes to balancing potential supply and aggregate demand for currently-produced goods and services, the government’s demand is as good as anybody else’s. Even if private businesses and households in aggregate do want to build up their holdings of financial assets in net–do what to spend less, collectively, than their collective income–the government can always spend more than its income to make up the slack.
“But”, you may say, “the fact that the government is running up its interest-bearing time-limited debt will further decrease private spending: people will fear that they need to build up reserves to pay off future taxes to amortize the debt, or uncertainty about how it will be paid off–or if–may cause people to desire to build up their hoards of ‘money’ even more.” Possibly. But if, as Michigan’s Miles Kimball puts it, the government simply prints money and buys stuff, there is no uncertainty about what future policy will be–it will be to keep the money circulating–and there will be no future taxes levied.
Absent some strange complicating factor–like a small open economy whose businesses owe huge amounts in exterior debt denominated in a harder, foreign currency–it is very difficult to see why simply printing money (and promising not to withdraw it) and buying stuff wouldn’t solve any “secular stagnation” problem we might have. A government that cannot print money, buy stuff, and credibly promise not to unwind its money-printing could be in trouble. And then the issue becomes: what is blocking the government from printing money, buying stuff, and credibly promising not to unwind its money-printing?