Secular stagnation is a poor excuse

This is my column for the October issue of Fund Strategy.

Few seem to have noticed how the role of mainstream economics has changed in recent years. In many cases it could reasonably be called the art of making excuses for poor economic performance.

Until a few years ago, many policymakers were congratulating themselves on how the world economy was doing. There were claims that technocrats trained in economics could guarantee economic stability. It was widely argued that by pursuing prudent policies and targeting inflation, the world’s central bankers could make crises a thing of the past.

Reality begged to differ. With the emergence of the economic crisis in 2008, growth numbers plummeted and the excuses for the poor performance of the developed economies multiplied. Some talked about a “new normal” of slow growth while others claimed the low-hanging fruit of technological innovation had all been picked. The most recent and probably most influential explanation is secular stagnation hypothesis.

Larry Summers, a former US Treasury secretary, coined the term at an International Monetary Fund (IMF) forum in November 2013. Many other influential figures have taken it up, including Paul Krugman (Nobel laureate in economics) and Martin Wolf (chief economics commentator of the Financial Times). It also had the IMF’s implicit support in its April 2014 World Economic Outlook. The 19 July edition of the Economist illustrated the idea with a cover image of a frustrated jockey trying to giddy up a giant tortoise draped in the American flag.

Now VoxEU.org, a policy portal set up by the Centre for Economic Policy Research in London, has published a free e-book on the topic ( Secular Stagnation: Facts, causes and cures Edited by Coen Teulings and Richard Baldwin (VoxEU.org 2014). It pulls together many of the main proponents of the hypothesis, including Summers, Krugman and Olivier Blanchard, the IMF’s chief economist.

There are different versions of secular stagnation but the editors identify three main points of consensus. The first is worth quoting in full: “A working definition of secular stagnation is that negative real interest rates are needed to equate saving and investment with full employment.”

The second concern is that secular stagnation makes it hard to achieve full employment with low inflation and official interest rates close to zero.

Finally, there is agreement that under the new conditions the old economic toolkit is inadequate. There is no consensus on the solutions needed but there is a widespread implication that mass unemployment may become a permanent scar on society. Summers suggests inflation targets could be raised. Krugman and others imply that fiscal stimulus may need to become a permanent feature of the West’s economic life. Many others favour conventional prescriptions such as increased investment in public infrastructure, improving education and simplifying procedures for establishing businesses.

The first thing to notice about the secular stagnation hypothesis is its limited character. Claiming that negative real interest rates are needed to equate savings and investment with full employment is merely an observation. A rough analogy is the fact that an earth day lasts about 24 hours. Although it is true it does not explain why the earth rotates on its own axis.

The contributors recognise that low real interest rates need to be explained but their arguments are not convincing. Summers points to a variety of structural factors such as slower population growth and possibly slower technological growth. But it is not clear why such variables are necessarily fixed or as influential as he describes.

There is not an adequate explanation of why so little weight is attached to such key economic indicators as profitability or investment levels. Nor is there a discussion of the extent to which the structure of the eurozone is itself contributing to low growth in continental Europe.

The secular stagnation hypothesis is a one-sided reaction to the economic crisis of recent years. Just as there was an overstatement of the world economy’s strength in the years leading up to 2008, so there is an exaggeration of its weaknesses today. A proper explanation of the plight of the global economy would need to probe the subject far more deeply.