Recent talk of secular stagnation has raised the question whether the US – and probably Europe and Japan – may not just be recovering slowly from a financial crisis, but may be permanently mired in an economic slump characterized by low growth, low inflation (or outright deflation), and stubborn, high unemployment.
Naturally enough, the idea that we may be living in a stagnant country ought to get us riled up as citizens. More immediately, though, those of us who make our living designing investment portfolios for others had better find out fast whether we’re in a slow recovery or an economic stagnation. If it’s the former, we more or less know how to design and manage portfolios.(1) If it’s the latter, we’ll need to go back to the drawing boards.
In my last post we looked at the history of the secular stagnation argument and found it seriously wanting. Originally proposed by Keynes (his “underemployment equilibrium”), the idea was enthusiastically endorsed by Keynes’ main American popularizer, Alvin Hansen, an economics professor at Harvard. Hansen’s book on the subject, Full Recovery or Stagnation?, appeared in 1938, just as the Depression was ending, and the economy that he assured us was stagnant proved to be the most productive in the history of the world.
The Keynesians promptly cut poor Hansen loose, adopting a practice pioneered by the economy they admired most (the Soviet Union), turning secular stagnation into an un-idea that would be erased from the history books. But it turns out that no idea is so bad that some economist somewhere won’t glom onto it again. A mere seventy-five years after Hansen’s book appeared – far, far too soon – a group of leftwing economists(2) resurrected the secular stagnation thesis. The vanguard of this group consisted of Paul Krugman(3) and Robert J. Goldman,(4) Keynesian voices anyone to the right of Mao can safely disregard.
Unfortunately, the cudgels were then taken up(4) by Larry Summers, an alarming voice to be added to this cacophony. Not only is Summers a serious personage – he has been a US Treasury Secretary, the President of Harvard, and was a finalist for the chairmanship of the Fed – but he is, for an economist, a more or less sensible fellow. So, unfortunately, we need to take the secular stagnation idea seriously.
Aside from the idiocy of the idea when it first appeared, the first objection to the secular stagnation argument is a simple one: before we conclude that our slow economic growth is being caused by a terrifying phenomenon that will force us to change everything we think and everything we do, perhaps we ought to ask ourselves whether there might not be a simpler explanation. As it turns out, there are at least two.
The first explanation is the one so thoroughly documented by Carmen M. Reinhart and Kenneth Rogoff in their iconic book, namely, that over the past eight centuries (!) financial crises have been spectacularly routine and they commonly cause growth over the next seven to fifteen years to be below trend.
The reasons for this unhappy outcome need not long detain us here, as they are set out in wonderfully footnoted splendor in the R2 book.(6) Suffice it to say that they have mainly to do with damage to the financial and banking sectors and a loss of confidence in the future by businesses and consumers.
But the very title of Reinhart and Rogoff’s book should have served as a warning to the secular stagnationists: “This Time It’s Different…” It isn’t different this time, say Reinhart and Rogoff, any more than it was different the last several hundred times over the last eight hundred years. The secular stagnationists, in other words, need to read their history.
The second explanation for our slow growth is the one championed by your humble blogger, and which my readers are no doubt getting tired of hearing: economic growth in a free market economy cannot be robust when that economy is being manipulated by central bankers. Extreme and unconventional interference in the US economy – and now in the European and Japanese economies – is the policy equivalent of dumping bagfuls of sand in the gears of those economies.
And because the interference has been so extreme and so prolonged, there is now no graceful way out. If you’re a central banker and you want to produce the “wealth effect,” you’d better be really sure that the wealth effect will also produce a strong economic recovery. Because if it doesn’t, and once investors realize this and bail, what you’ll have created is the “poverty effect.” Instead of recovering, the economy will drop into another recession. You will then have to pull even more bags of sand out of your kit bag, leading to another vicious cycle of wealth-effect-to-poverty-effect.
In practice, the Western economies have been centrally managed now for seven years running, and yet we ask ourselves why our growth is so slow? The question answers itself.
Thus, we find that the secular stagnation thesis already has two strikes against it: when originally proposed the idea was farcical, and there are far simpler explanations for slow economic growth. Strike three is the rationale for the thesis. We’ll look at that curve ball in my next post.
(1) I.e., be wary of those assets that have been supercharged by central banker stimulus and begin to assemble assets that have fortuitously escaped the bankers’ clutches.
(2) I know, it’s redundant, given that the center of the economics profession, represented by, say, Janet Yellen, is already far to the left of the center of the American polity.
(3) Krugman’s contributions to secular stagnationism have arrived mainly through his New York Times column and his blog. See “Secular Stagnation, Coalmines, Bubbles, and Larry Summers,” New York Times, 11/16/13, and “Three Charts on Secular Stagnation,” Blog, New York Times, 5/7/14.
(4) See “The Demise of U. S. Economic Growth: Restatement, Rebuttal, and Reflections,” NBER Working Paper No. 19895, February 2014.
(5) A cudgel, as you probably know, is a club used as a weapon. The phrase “take up the cudgels” was popularized by, of all people, those early Keynesians, Marx and Engels, who wrote, “In countries like France, where the peasants constitute far more than half of the population, it was natural that writers … should take up the cudgels for the working class.” The Communist Manifesto.
(6) Reinhart and Rogoff, as I’ve already noted (“On NIRP, Part 3, post of 4/16/15), as opposed to R3, Reinhart, Reinhart and Rogoff. Yes, the Reinhart’s are married, and to each other, a lot of IQ points to be jammed into one nuptial.
Next up: Slow Recovery or Secular Stagnation? (Part 3)
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