A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Thursday, January 30, 2014

Secular Stagnation

Today on the podcast, good news and bad news.

Good news is, a group of econophiles in Seattle and the Northwest has incorporated the nonprofit Institute for Dynamic Economic Analysis. The mission is nothing less than the comprehensive reform of economics. Our chief economist is Steve Keen, whose books and lectures and videos demonstrate his fitness for the task. Our executive director is your obedient servant here speaking. Members of our board include Michael Hudson and Dirk Bezemer. The website is still under construction, but you can find it at IDEAeconomics.org.
Listen to this episode
The bad news is: That's it for the Demand Side podcast. What? Now six years and change, 618 episodes. Rushing to get in place in November 2007 in time to call the recession. Now all these years later, and we still haven't called the end of the recession. Bouncing along the bottom with downside risks.

We will continue to post raw relays here, from voices we think may be useful. Weekly is our intention. But our distinctive dour look will be moving over to the IDEA blog. It may be, in coming months, we'll generate a podcast from that site, but our energies are now elsewhere: supporting the work under Steve -- including his forthcoming Finance and Economic Breakdown, facilitating the development and use of Minsky-- the dynamic modeling software that incorporates credit and banking, providing the blog forum for disciplined discussion of relevant posts, coordinating with like-minded individuals and organizations, offering access to data and research tools, hopefully for every level, and delivering you the opportunity to contribute money, time and talent to the necessary reformation of a quasi-science. Maybe we can raise something that deals with the real world in useful ways.

As I say, we are just getting started at IDEA -- an acronym too cute by half. What you get when you look at the website is a preview, here ahead of the rest of the world, because I have to explain the shutdown. Our official roll out is February 17. If you want to be on that first e-mail list, send your name and e-mail address to demandside at live.com.

So again, relays continue here, but in a less sophisticated -- if that is possible -- format.

All this does not explain the new look at DemandSideEconomics.net, the site -- or former site -- of the transcripts. Somehow, perhaps by my distraction with this new venture, we lost control of the Domain Name. The next day it is what you see there. No content, but at least it is not porn. We are in the process of moving the transcripts to demandsidetranscript.net, but have not yet been able to master the technicalities of that. You can find everything at demandsideblog.blogspot.com in the meantime.

Now, all that aside, on to today's podcast. It is a relay of sorts. It is the "secular stagnation" speech Larry Summers gave at the IMF a couple of weeks ago, which we reproduce in its entirety. We do that not because of its substance, but because of the remarkable absence of substance. The audience does not want to hear such heresy, and Larry must step lightly. It is wonderful to witness.

You all know Mr. Summers. One-time member of the three amigos -- Summers, Robert Rubin and Alan Greenspan, feted on the cover of TIME for their competence in producing the New Economy of the 1990's. Larry is aggressive and caustic. Champion of deregulation -- with Rubin and Greenspan. Later failed president of Harvard. Architect of the Timely, Targeted and Temporary stimulus package in the spring of '08 that also turned out to be ineffectual. Later Obama's chief economist -- to the chagrin of Austin Goolsbee who was Barack's chief advisor during the '08 campaign and actually landed the slot as chief of the Council of Economic Advisers. Summers is largely credited with choosing the stimulus that was too small and very badly designed. You'll remember the promises of 8-1/2 percent unemployment that turned out much higher and went a long way to discrediting federal spending as an antidote to recession. Obama famously said, "Heckuva job, Larry," on a Sunday talk show as Larry was leaving. Adding, "pun intended." Summers is also one of the recipients of the Dynamite Prize from Real World Economic Review, along with fellow amigo Alan Greenspan and arch-monetarist Milton Friedman, as the three who did most to blow up the economy.

Here he is bowing and curtsying to Stan Fischer, new vice chair at the Fed, Ben Bernanke, and others. The audio is followed by a few notes from Paul Krugman, who does his own genuflecting before beginning.


What does "secular stagnation" mean. As near as we can tell, its usage here is analogous to the work of Ptolemaic astronomers. Whenever a new star was identified, and in order to fit its movement in to the belief that the Earth was the center of the universe, a new celestial sphere had to be invented and described and explored and so on. Here we have a phenomenon, secular stagnation -- the rotting of middle class conditions. Many years of study and pontification have to be expended to fully integrate this into the previous economic theories.

OR you could look at Keynes, Irving Fisher, Keyserling, Minsky, Galbraith the elder, Galbraith the younger, Steve Keen, Michael Hudson and a good many more who have been describing it for years, with demand at the center. As Keynes said and James Galbraith repeated in his excellent book The Predator State, there is no supply curve for labor. It is all about demand.

This fussing around with the zero lower bound and so-called natural rate of interest being below zero is so much needless befuddlement. If the natural rate of interest means anything, it is the expected return on investment. Why not raise the expected return, rather than try to lower the interest rate? That would mean public investment, public jobs, doing things that need to be done.

On the other hand, you need to give Summers a little credit. Among those years of secular stagnation are some that he is responsible for. At least he took the credit at the time.

What does Paul Krugman have to say?

Here I have to tread lightly and maybe do a half a bow. I know Krugman is a favorite of some of the listeners. He writes very well. He can describe the shortcomings of the Right in exquisite detail. His overall critique of others is good. But his policy prescriptions. They are in the right direction, but this fascination with the zero lower bound. And more, his suggestion that it would all be so simple. We think ... well, let's just say it ignores some institutional obstacles.

Krugman's piece is worth reading. It is appended to the transcript, if you can get there. demandsideblog.blogspot.com or, coming soon, demandsidetranscript.net.

So there you have it, the last episode of the Demand Side podcast. As I say, whether because we can't let go or because we want you to have something worthwhile to listen to, we will be publishing relays of others in the future. We've learned a lot. Thank you for listening.

Today's podcast brought to you by IDEA, an acronym too cute by half, but it does mean something. The Institute for Dynamic Economic Analysis, IDEAeconomics.org. Look for it February 17.

This is Alan Harvey, from the Demand Side.


I’m pretty annoyed with Larry Summers right now. His presentation at the IMF Research Conference is, justifiably, getting a lot of attention. And here’s the thing: I’ve been thinking along the same lines, and have, I think, hinted at this analysis in various writings. But Larry’s formulation is much clearer and more forceful, and altogether better, than anything I’ve done. Curse you, Red Baron Larry Summers!

OK, with professional jealousy out of the way, let me try to enlarge on Larry’s theme.

1. When prudence is folly

Larry’s formulation of our current economic situation is the same as my own. Although he doesn’t use the words “liquidity trap”, he works from the understanding that we are an economy in which monetary policy is de facto constrained by the zero lower bound (even if you think central banks could be doing more), and that this corresponds to a situation in which the “natural” rate of interest – the rate at which desired savings and desired investment would be equal at full employment – is negative.

And as he also notes, in this situation the normal rules of economic policy don’t apply. As I like to put it, virtue becomes vice and prudence becomes folly. Saving hurts the economy – it even hurts investment, thanks to the paradox of thrift. Fixating on debt and deficits deepens the depression. And so on down the line.

This is the kind of environment in which Keynes’s hypothetical policy of burying currency in coalmines and letting the private sector dig it up – or my version, which involves faking a threat from nonexistent space aliens – becomes a good thing; spending is good, and while productive spending is best, unproductive spending is still better than nothing.

Larry also indirectly states an important corollary: this isn’t just true of public spending. Private spending that is wholly or partially wasteful is also a good thing, unless it somehow stores up trouble for the future. That last bit is an important qualification. But suppose that U.S. corporations, which are currently sitting on a huge hoard of cash, were somehow to become convinced that it would be a great idea to fit out all their employees as cyborgs, with Google Glass and smart wristwatches everywhere. And suppose that three years later they realized that there wasn’t really much payoff to all that spending. Nonetheless, the resulting investment boom would have given us several years of much higher employment, with no real waste, since the resources employed would otherwise have been idle.

OK, this is still mostly standard, although a lot of people hate, just hate, this kind of logic – they want economics to be a morality play, and they don’t care how many people have to suffer in the process.

But now comes the radical part of Larry’s presentation: his suggestion that this may not be a temporary state of affairs.

2. An economy that needs bubbles?

We now know that the economic expansion of 2003-2007 was driven by a bubble. You can say the same about the latter part of the 90s expansion; and you can in fact say the same about the later years of the Reagan expansion, which was driven at that point by runaway thrift institutions and a large bubble in commercial real estate.

So you might be tempted to say that monetary policy has consistently been too loose. After all, haven’t low interest rates been encouraging repeated bubbles?

But as Larry emphasizes, there’s a big problem with the claim that monetary policy has been too loose: where’s the inflation? Where has the overheated economy been visible?

So how can you reconcile repeated bubbles with an economy showing no sign of inflationary pressures? Summers’s answer is that we may be an economy that needs bubbles just to achieve something near full employment – that in the absence of bubbles the economy has a negative natural rate of interest. And this hasn’t just been true since the 2008 financial crisis; it has arguably been true, although perhaps with increasing severity, since the 1980s.

One way to quantify this is, I think, to look at household debt. Here’s the ratio of household debt to GDP since the 50s:

Ratio of household debt to GDP
Ratio of household debt to GDP
There was a sharp increase in the ratio after World War II, but from a low base, as families moved to the suburbs and all that. Then there were about 25 years of rough stability, from 1960 to around 1985. After that, however, household debt rose rapidly and inexorably, until the crisis struck.

So with all that household borrowing, you might have expected the period 1985-2007 to be one of strong inflationary pressure, high interest rates, or both. In fact, you see neither – this was the era of the Great Moderation, a time of low inflation and generally low interest rates. Without all that increase in household debt, interest rates would presumably have to have been considerably lower – maybe negative. In other words, you can argue that our economy has been trying to get into the liquidity trap for a number of years, and that it only avoided the trap for a while thanks to successive bubbles.

And if that’s how you see things, when looking forward you have to regard the liquidity trap not as an exceptional state of affairs but as the new normal.

3. Secular stagnation?

How did this happen? Larry explicitly invokes the notion of secular stagnation, associated in particular with Alvin Hansen (pdf). He doesn’t say why this might be happening to us now, but it’s not hard to think of possible reasons.

Back in the day, Hansen stressed demographic factors: he thought slowing population growth would mean low investment demand. Then came the baby boom. But this time around the slowdown is here, and looks real.

Think of it this way: during the period 1960-85, when the U.S. economy seemed able to achieve full employment without bubbles, our labor force grew an average 2.1 percent annually. In part this reflected the maturing of the baby boomers, in part the move of women into the labor force.

This growth made sustaining investment fairly easy: the business of providing Americans with new houses, new offices, and so on easily absorbed a fairly high fraction of GDP.

Now look forward. The Census projects that the population aged 18 to 64 will grow at an annual rate of only 0.2 percent between 2015 and 2025. Unless labor force participation not only stops declining but starts rising rapidly again, this means a slower-growth economy, and thanks to the accelerator effect, lower investment demand.

By the way, in a Samuelson consumption-loan model, the natural rate of interest equals the rate of population growth. Reality is a lot more complicated than that, but I don’t think it’s foolish to guess that the decline in population growth has reduced the natural real rate of interest by something like an equal amount (and to note that Japan’s shrinking working-age population is probably a major factor in its secular stagnation.)

There may be other factors – a Bob Gordonesque decline in innovation, etc.. The point is that it’s not hard to think of reasons why the liquidity trap could be a lot more persistent than anyone currently wants to admit.

4. Destructive virtue

If you take a secular stagnation view seriously, it has some radical implications – and Larry goes there.

Currently, even policymakers who are willing to concede that the liquidity trap makes nonsense of conventional notions of policy prudence are busy preparing for the time when normality returns. This means that they are preoccupied with the idea that they must act now to head off future crises. Yet this crisis isn’t over – and as Larry says, “Most of what would be done under the aegis of preventing a future crisis would be counterproductive.”

He goes on to say that the officially respectable policy agenda involves “doing less with monetary policy than was done before and doing less with fiscal policy than was done before,” even though the economy remains deeply depressed. And he says, a bit fuzzily but bravely all the same, that even improved financial regulation is not necessarily a good thing – that it may discourage irresponsible lending and borrowing at a time when more spending of any kind is good for the economy.

Amazing stuff – and if we really are looking at secular stagnation, he’s right.

Of course, the underlying problem in all of this is simply that real interest rates are too high. But, you say, they’re negative – zero nominal rates minus at least some expected inflation. To which the answer is, so? If the market wants a strongly negative real interest rate, we’ll have persistent problems until we find a way to deliver such a rate.

One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom – whether it’s a bubble or driven by expansionary fiscal policy – to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations.

Any such suggestions are, of course, met with outrage. How dare anyone suggest that virtuous individuals, people who are prudent and save for the future, face expropriation? How can you suggest steadily eroding their savings either through inflation or through negative interest rates? It’s tyranny!

But in a liquidity trap saving may be a personal virtue, but it’s a social vice. And in an economy facing secular stagnation, this isn’t just a temporary state of affairs, it’s the norm. Assuring people that they can get a positive rate of return on safe assets means promising them something the market doesn’t want to deliver – it’s like farm price supports, except for rentiers.

Oh, and one last point. If we’re going to have persistently negative real interest rates along with at least somewhat positive overall economic growth, the panic over public debt looks even more foolish than people like me have been saying: servicing the debt in the sense of stabilizing the ratio of debt to GDP has no cost, in fact negative cost.

I could go on, but by now I hope you’ve gotten the point. What Larry did at the IMF wasn’t just give an interesting speech. He laid down what amounts to a very radical manifesto. And I very much fear that he may be right.



1 comment:

  1. Very sorry to see the end of this podcast, and about your troubles with your domain name. I had thought you dropped out somehow. Good luck with future endeavors!