I have written a couple of pieces for Economy Lab in the Globe and Mail recently on the issue of secular stagnation. (Links below)
The term was coined by the pioneering American Keynesian Alvin Hansen who argued that the US economy of the late 1930s faced a long period of stagnation due to a chronic, structural gap between aggregate supply (the capacity of the economy to produce) and aggregate demand.
Keynesians of the time argued that the solution to stagnation underpinned by low private investment was public investment led growth, and were vindicated to a degree when World War Two finally drove a lasting recovery.
I was very impressed by the recent book by Daniel Alpert on this theme, The Age of Oversupply. Alpert’s key argument is that – on top of the deflationary pressures arising from a collapsed housing bubble and financial crisis – the advanced industrial world is only slowly adjusting to the enormous increase in productive capacity that took place when millions of workers in the developing world, especially China, joined the global labour force as part of a process of export-led industrialization and growth.
Collectively, the developing world has added much more to global supply than to global demand. This problem was papered over before the Great Recession, by recycling developing-country export surpluses and savings to finance debt-fuelled household consumption and government deficits in the advanced industrial world. But chronic oversupply now weighs heavily on new investment. This will not be effectively offset by low interest rates.
Some two years ago, Larry Summers debated Paul Krugman in Toronto and rejected the case for pessimism about medium-term recovery. His key point was that the (too ow) Obama stimulus package plus loose monetary policy would do the job. Summers is an uber establishment economist having served as US Secretary to the Treasury under Clinton and as Obama’s closest economic adviser.
But Summers recently joined the ranks of the stagnationists in a widely publicized speech to an IMF conference. He now argues that the “natural rate of interest,” the real interest rate needed to bring the U.S. economy back to full employment with price stability, is significantly below zero. Moreover, he argues that this was the case even before the Great Recession, when there were no inflationary pressures and significant unemployment in the midst of what turned out to be an unsustainable financial bubble fueled by cheap credit.
This speech puts Summers squarely in the camp of those who argue that even ultra-loose monetary policy cannot get us out of long-term stagnation, and that we must turn to fiscal policy to deal with the problem. Indeed, even before his IMF speech, Summers published a major paper with Brad De Long arguing for more debt-financed public investment to promote a stronger recovery.
If Summers is right, the prospects for a Canadian recovery driven by rising exports to the US and increased business investment are pretty dismal.
But, here in Canada, it seems that remarkably few mainstream economists are prepared to argue the case for fiscal stimulus and public investment led growth as supported, most notably, by the CCPA Alternative Federal Budget.
The conventional wisdom, that exports and business investment will drive a stronger recovery, is trotted out by the Bank of Canada and economic forecasters on a regular basis, and then it is sadly announced that this recovery will take longer than expected.
Perhaps it is time to get our heads around the idea that a robust recovery is just not going to happen in the absence of appropriate fiscal policy, just as Hansen argued.