Wednesday, December 11, 2013

Secular stagnation.... just a poor excuse?

Larry Summers recently made some waves with his proposal that maybe we're in a new era of "secular stagnation," in which low growth is the norm, and much of it comes through temporary and artificial bubbles. Paul Krugman backed the idea here. At face value, it all seems somewhat plausible, but also sounds a lot like a "just so" story to cover up and explain why economic policy and low interest rates haven't been enough to encourage new growth, yet also haven't caused inflation. It also fits together quite well with the usual stories told about the failure of ordinary policy at the zero lower bound, which turns ordinary economics on its head.

Now, I don't want to say that story is completely wrong, but remember that it comes out of quite standard macro analyses based on representative agent models with individuals and firms optimizing over time, and where -- perhaps most importantly -- things like debt overhang do not enter in any way into explaining how people are behaving (and why they may be hugely risk averse). That should be enough to raise some major questions about the plausibility of the story, especially in the aftermath of the biggest financial crisis in a century. For a lot more on such doubts, see the illuminating recent paper Stable Growth in an Era of Crises by Joseph Stiglitz.

But also see this convincing counterargument by some analysts at Independent Strategy, as discussed in the Financial Times. From Izabella Kaminska's discussion:
From the note, their main points are:
• There is no shortage of high return investment projects in the world. And the dearth of global corporate investment, which drove the great recession, means that productive potential is shrinking despite corporate profitability, leverage and cash balances being sound.

• The three ingredients for growth are a) a stable macro environment; b) a sound banking system; c) economic reforms that encourage entrepreneurship. What is missing right now is private sector confidence in the ability of governments and central bankers to provide all three.

• Credit bubbles can boost growth only temporarily and incur heavy costs in terms of subsequent deleveraging and misallocation of resources.
And expanding a bit further, they add:
Secular stagnation is a myopic and short-term view for two reasons. First, it is based on the experience of the Anglo-Saxon economies and parts of Europe currently as well as Japan since the bursting of the bubble at the start of the 1990s. Krugman muses that interest rates should be set at the growth rate of populations, because they would then be equal to a society’s potential capital productivity (and the long-term return on it). But the change in population growth is less relevant than the rise in productivity of an expanding workforce.

Take Germany: its population is ageing and its net population growth is slowing to a trickle (although that may be improved by increased net immigration from southern and eastern Europe). But Germany’s productivity level and growth is high (as is total factor productivity, expressing the gains from technology). Italy has a similar stagnation in its working population, but its real GDP growth has disappeared because of the fall in total factor productivity — Figure 1.
 Read Kaminska's discussion here.

Actually, this push back isn't really surprising. It's what you get if you take the longer historical view, rather than trying to make excuses for why economic theory still can't make sense of things (the theory is poor, that's why!). As a couple of economists from Goldman Sachs noted just after Summers' speech:
"Our view of the recent weakness is more cyclical than secular... The slow rate of recovery in recent years is roughly in line with the performance of other economies following major financial crises, as shown by Reinhart and Rogoff, and the reasons for the weakness in aggregate demand over the last few years have now begun to diminish."
This refers to the great book by Reinhart and Rogoff, by the way, not their other discredited paper.

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