Thursday, February 25, 2016

Inequality and Slow Growth: Secular Stagnation

Sometimes economic analyses can be expressed quite simply.  The economy of a society consists of consumers buying things from sellers.  The greater the frequency of these transactions the higher the income of the society and the greater is its GDP.  For the consumers to continue buying, they must have a source of income that matches the rate at which they make purchases.  If the level of income falls below the spending rate then consumers have the option of borrowing money or decreasing their purchase rate.  Borrowing to support consumption merely delays the day of reckoning and makes the slowing purchase rate that much more extreme when it finally occurs.  Nearly all of the economies of developed countries have been experiencing slower than expected growth in GDP since the Great Recession and economists have been wondering why. 

Sometimes economists get trapped within their jargon and their models and are unable to deal with egregious factors.  Larry Summers finally grasped the obvious and explained it in a manner that even other economists could comprehend.  He published his analysis in Foreign Affairs in an article titled The Age of Secular Stagnation: What It Is and What to Do About It.

Economists expected the Great Recession to be followed by a period of healthy growth as economies returned to a “normal” state.  Summers summarizes what actually occurred.

“Almost no one in 2009 imagined that U.S. interest rates would stay near zero for six years, that key interest rates in Europe would turn negative, and that central banks in the G-7 would collectively expand their balance sheets by more than $5 trillion. Had economists been told such monetary policies lay ahead, moreover, they would have confidently predicted that inflation would become a serious problem—and would have been shocked to find out that across the United States, Europe, and Japan, it has generally remained well below two percent.”

In spite of central banks trying to encourage more growth, monetary policies have been ineffective.  And it looks as though low growth is expected to continue indefinitely.

“….it is fair to say that inflation for the entire industrial world is expected to be close to one percent for another decade and that real interest rates are expected to be around zero over that time frame. In other words, nearly seven years into the U.S. recovery, markets are not expecting “normal” conditions to return anytime soon.”

Summers summons “secular stagnation” as the concept required to explain the situation.

“The economies of the industrial world, in this view, suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. The result is that excessive saving acts as a drag on demand, reducing growth and inflation, and the imbalance between savings and investment pulls down real interest rates.”

In other words, buyers do not have enough money to create a demand for sellers’ products sufficient to encourage sellers to invest in the means of producing more goods.  Consumers who are not buying or borrowing are said to be “saving.”

Summers makes clear what the problem is with demand.

“Greater saving has been driven by increases in inequality and in the share of income going to the wealthy, increases in uncertainty about the length of retirement and the availability of benefits, reductions in the ability to borrow (especially against housing)….”

Wages for the vast majority of people have been stagnant for decades.  Nearly all the growth of income since the financial collapse has gone to a small number of individuals.  Not surprisingly, wealthy people like to watch their wealth accumulate rather than returning all of it to the economy.  Inequality dampens both demand and investment.

The policies that have led to this long-term slowing of economic activity produce collateral damage.

“More important, these policies are running into diminishing returns and giving rise to increasingly toxic side effects. Sustained low rates tend to promote excess leverage, risk taking, and asset bubbles.”

The major thrust of policy should be to increase demand through fiscal stimulus.

“The core problem of secular stagnation is that the neutral real interest rate is too low. This rate, however, cannot be increased through monetary policy. Indeed, to the extent that easy money works by accelerating investments and pulling forward demand, it will actually reduce neutral real rates later on. That is why primary responsibility for addressing secular stagnation should rest with fiscal policy. An expansionary fiscal policy can reduce national savings, raise neutral real interest rates, and stimulate growth.”

Summers indicates that an aggressive public investment policy is needed to repair our decaying infrastructure and now is an ideal time to move forward on it.

“Fiscal policy has other virtues as well, particularly when pursued through public investment. A time of low real interest rates, low materials prices, and high construction unemployment is the ideal moment for a large public investment program. It is tragic, therefore, that in the United States today, federal infrastructure investment, net of depreciation, is running close to zero, and net government investment is lower than at any time in nearly six decades.”

One should not lose sight of the fact that increasing the income of consumers so that they may spend more and elevate aggregate demand is the crucial need.

“Other structural policies that would promote demand include steps to accelerate investments in renewable technologies that could replace fossil fuels and measures to raise the share of total income going to those with a high propensity to consume, such as support for unions and increased minimum wages. Thus, John Maynard Keynes, writing in a similar situation during the late 1930s, rightly emphasized the need for policy approaches that both promoted business confidence—the cheapest form of stimulus—and increased labor compensation.”

People will argue that debt is already high and assuming more debt is the wrong approach, but history tells us that the best way to diminish national debt is by fostering high growth and modest inflation.  That is the path that led to elimination of the enormous debts accumulated during World War II.  

Summers also reminds us that inequality has social as well as economic consequences.

“Secular stagnation and the slow growth and financial instability associated with it have political as well as economic consequences. If middle-class living standards were increasing at traditional rates, politics across the developed world would likely be far less surly and dysfunctional. So mitigating secular stagnation is of profound importance.”

How true!

1 comment:

  1. Nicely written. Don't know if Larry Summers is any more correct in his diagnosis than any other economist, but his theory is interesting, if nothing else.



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