VoxEU, the indispensable economic-policy website of the Center for Economic Policy Research, has outdone itself with a new e-book on secular stagnation. This is the most important conversation in applied macroeconomics -- but it's complicated and confusing, too. Editors Richard Baldwin and Coen Teulings and a team of eminent contributors have produced the first comprehensive and reasonably accessible survey of the issue. It's essential reading.
What exactly is secular stagnation? In their introductory essay, the editors explain that it involves three distinct but related possibilities.
- A persistent gap between actual and potential output. Because of an imbalance between saving and investment, the nominal interest rate required to maintain full employment falls to less than zero -- not just briefly, but persistently. Since the rate can't be cut to less than zero, monetary policy (as currently conceived) can't keep the economy running at full potential.
- A slowdown in growth of potential output. This may happen because of demographic changes, or because innovation isn't what it used to be, or for other reasons.
- An irreversible drop in the level of potential output. Even if the full-employment rate of interest is still positive and the growth in potential output hasn't slowed, the recession may have permanently cut its level -- for instance, by causing workers to leave the labor force and not come back. Even if the economy now grows as fast as it did before, it's on a lower track and won't ever converge with the path it was on pre-crash.
The term "secular stagnation" should probably be confined to the first of these ideas. That's what it meant in the 1930s, when it was coined; and that's the issue that preoccupies Larry Summers, who contributes a lead essay to the VoxEU ebook and who started this discussion with a talk he gave last year. However, the other two variants tend to get bundled up with the argument about interest rates, forming a single seamless pessimism.
This bundling is somewhat justified, unfortunately, because the ideas, though distinct, have connections. For instance, aging populations may increase the supply of saving (thus lowering the equilibrium interest rate and keeping the economy at less than full capacity) while also shrinking the working-age population (thus depressing the growth of potential output). Or suppose innovation is a fading force. That could diminish the opportunities for profitable investment (adding to the problem of excess saving) while also holding back productivity (directly braking growth in potential output).
All three versions of secular stagnation could be true -- and all three, in fact, are more plausible than one could wish. (See especially Summers's contribution on the first variant, Robert Gordon's on the second, and Edward Glaeser's on the third.) That doesn't make these outcomes probable, though, much less inevitable. Barry Eichengreen nicely sums things up:
So is there a secular stagnation problem? Yes, there are reasons to worry that the U.S. growth rate over the next 10 or 20 years will disappoint by the standards of the 20th century. But this is not inevitable. It will not be because all the great inventions have been made or because there is a dearth of attractive investment projects and an overabundance of savings. If the U.S. experiences secular stagnation, the condition will be self-inflicted.
Eichengreen's point is that the problems encompassed by the secular-stagnation theory all have remedies. Suppose, to consider the worst case, that the saving-investment imbalance is allowed to persist and the full-employment rate of interest stays below zero. Central banks could raise the target rate of inflation from 2 percent to, say, 4 percent. This would raise the equilibrium interest rate too. Problem solved.
Yes, this course of action would be very difficult for most central banks to contemplate: Making the existing targets credible in the first place wasn't easy. Yet it needn't come to that. Governments could attack the excess of savings instead: by spending more on education and infrastructure; by cutting taxes to encourage households to consume and firms to invest; by encouraging innovation; by boosting the supply of labor (for instance, by raising the retirement age or improving the incentives for low-paid workers); by promoting competition (which spurs efficiency and rewards investment). In short, by doing a lot of things they should probably be doing anyway.
I'll come back to each branch of the secular-stagnation theory in more detail. For now, thanks to VoxEU for providing such an outstanding text.
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