Secular Stagnation 2

Secular Stagnation – not about church or politics – instead the idea that the developed world could be constrained to a future of persistent slow growth.

Base rates of the UK,  EU and USA central banks.

Base rates of the UK,
EU and USA central banks.

Most people have never heard of secular stagnation (unless they lived in 1938) until Larry Summers’ (Harvard University) speech at the IMF in November 2013 breathed new life into the phrase. He claimed that since the recession of 2008, the “zero lower bound” on interest rates had become an almost familiar sight, when most economists had expected it to be merely a temporary adjustment following the recession.

I Rates Post ItA low interest rate is meant to make saving money less attractive (why bother having money in the bank if you are not being rewarded for storing it there?) and encourage investment (borrowing money becomes cheap which should encourage more people and businesses to get loans from the bank).

Instead, in the current economic climate,businesses and individuals are reluctant to spend money or make new investments, even though borrowing money is now cheap. The ISI Group, which provides firms/businesses with information regarding what the best investment opportunities might be, has noted that since 2008, firms in the US, Eurozone and Japan have been net savers rather than borrowers. Even though borrowing money is very cheap, businesses are not doing so!

tt121004This means that the interest rate offered by the central banks is not low enough! It needs to go below zero (i.e. it needs to become negative so that people with lots of savings in the bank start spending their money instead of hoarding it) but it cannot, because otherwise, people would start taking their money out of banks and begin storing it under their beds, in cupboards…wherever no one will find it. Also, who will lend someone R100 if he is only going to pay you back R95?

So this is the big problem that Summers claims is plaguing developed economies – the floor on interest rates – which he thinks is going to continue for a long time and thereby impede growth. In order for companies and countries (GDP) to grow, people need to be spending money. Businesses need to be investing in new iphones, smart watches and Google Glasses and selling more of them so that they can increase output (make more things), increase productivity (make more things for less) and hire more people!

Growth rate comparison between the US, EU, UK and China. Note, developed countries have a low growth rate.

Growth rate comparison between the US, EU, UK and China. Note, developed countries have a low growth rate.

Either you need a growing population so that demand for goods and services keep increasing (every new born baby needs new clothes and more food etc), or you need workers to be working more productively. In developed economies, population growth rates have stalled and the ratio of workers (those under 64) to retirees (those over 65) has decreased (See this Economist article). So, with fewer workers to rely on (unless developed countries dramatically change their immigration policies), growth will have to come in the form of increased productivity. And for increased productivity, you need investment! Since the interest rate is unable to encourage businesses and people to do all of this investing and spending, there sadly won’t be very many new innovative products in the future and GDP growth will be low and slow.

Unless something else can be done to encourage businesses and people to spend money.

Summers’ solution: Allow people to borrow money recklessly! That is – lend money to everyone and anyone – even people who cannot afford to pay you back (wouldn’t you love a “no strings attached” lump sum cash handout?). But, wasn’t that the reason for the whole economic recession in the first place?

There has been some significant reaction to his controversial claim. Some Economists, have followed suit in claiming that the US now faces a new era of slow growth. Paul Krugman in particular was emphatic in support mentioning that in an economy facing a liquidity trap (nominal interest rates approaching zero) “savings may be a personal virtue, but it’s a social vice”.

Other theories have also been proposed for the slow growth experienced by developed countries. The trio of economist Robert Gordon, investor Peter Thiel and popular writer Tyler Cowen propose that the slow growth seen is a structural phenomenon due to a slowdown in the rate of technological progress. More investment might not necessarily relate to greater progress. Their ideas are expanded in The Great Stagnation.

Others have argued that bad government policies instead are to blame (John Taylor Stanford), or that we are merely approaching the fundamental limits to the expansion of human economic activity (Limits to Growth hypothesis).

Yet, despite the storm created in the aftermath of Summers’ 2013 speech, there have since been some suggestions that the fated secular stagnation of Summers is not going to be realised. Jari Stehn, an economist from Goldman Sachs revisited Summers’ hypothesis almost a year later. He argued that according to the Goldman Current Activity Indicator, the US economy grew at 3% in 2014, which was the fastest rate of growth since the recession. He concludes that the growth problem in the US might be more cyclical rather than secular, though the growth problems in the Eurozone look to be more long term in nature.

Marc Andreesson, a famoSummers Tweetus US entrepreneur, also created a tweetstorm over Summers’ secular stagnation hypothesis, instead claiming that the economy has too much capital and too few investment opportunities (perhaps due to red tape). Of course, Larry Summers was quick to respond.

There is much more that can be said, indeed there is even a free ebook that you can download that has all the latest research and arguments around the theme. What remains clear however, is that there is slow growth in the developed economies and that without a long term solution to the underlying demographic problem of low population growth, the productivity growth needed to offset the reduction in workers may not be enough to free developed economies from long term slow growth rates.


  1. Pingback: Inflation – where have you gone? « School of Economics

  2. Pingback: Inflasie – waar is jy? | Die Ekonomie Blog

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s