Blowing bubbles and the stagnation puzzle

I’m sorry, I couldn’t help it: when Larry Summers first made his secular stagnation speech at the IMF, and the American economics tribe heralded it as if it were the greatest (and latest) thing since sliced bread, my irony gene went into overload – and that showed in my first post on the topic. The argument that the West has been suffering from secular stagnation, and that only a series of financial bubbles have kept the illusion of prosperity going, has been part of non-orthodox economics for over three decades.

Much of this has been in the real underworld of economics, emanating from the handful of avowedly Marxist economists that have survived in academic institutions and non-mainstream media. But issues such as the impact of transnational corporations relocating production to third world free trade zones have been hot topics amongst non-mainstream economists for decades (for instance, I wrote my first piece on this topic in 1979 – here’s the somewhat dated Technical Appendix for wonks).

Back then, the reaction of mainstream economists to this perspective was at best a deafening silence, and at worst derision. Weren’t these the lefties who were always expecting the final crisis of capitalism, even after the fall of the Berlin Wall?

Of course, there was more than a grain of truth to that riposte. But rather than tackling the secular stagnation arguments directly, mainstream economists dismissed them with derision, in the sublime confidence that capitalism could never have crises. My favorite such statement was by Edward Prescott (who, with Finn Kydland got the Nobel Prize for inventing the “real business cycle, representative agent” approach to economics that still dominates the mainstream today). Entitled Some Observations on the Great Depression and written in 1999, it concluded with this rhetorical flourish:

Yeah, right. One decade later, that opening Marxist sentence began to sound a lot more realistic than Prescott’s dismissal of it.

Of course, mainstream economists could never acknowledge the prior arguments of a rival intellectual tradition, but now that Larry (peace be upon him) Summers has said it, suddenly it’s OK to spout what the lefties have been saying for 30 years (though with different explanations, of course – it’s declining population growth and falling levels of innovation, not nasty transnationals relocating production, or financialisation of the economy white-anting the industrial sector).

Oh give me a break – hence the irony. But since Summers’ take on secular stagnation looks like it will be the flavour of the month for American economists for the foreseeable future, I have to take it more seriously. Hence this more serious post for my first column in 2014, which builds on the last two on this topic – and with no irony whatsoever.

But I’ll commence with two caveats: yes secular stagnation is real, but it has far more to do with reasons the mainstream has always rejected than with anything it will dream up post-Summers; and the lefties got there first.

That said, let’s get academic over how “secular-stagnation-augmented Loanable Funds” might allow Neoclassicals to take private debt seriously some of the time…

The crisis of 2007/08 has generated many anomalies for conventional economic theory, not the least that it happened in the first place. Though mainstream economic thought has many channels, the common belief before this crisis was that either crises cannot occur, or that the odds of such events had either been  reduced or eliminated courtesy of the scientific understanding of the economy that mainstream theory had developed.

This anomaly remains unresolved, but time has added another that is more pressing: the fact that the downturn has persisted for so long after the crisis. Recently Larry Summers suggested a feasible explanation in a speech at the IMF. “Secular stagnation”, Summers suggested, was the real explanation for the continuing slump, and it had been with us for long before this crisis began. Its visibility was obscured by the Subprime Bubble, but once that burst, it was evident.

This hypothesis asserts, in effect, that the crisis itself was a second-order event: the main event was a tendency to inadequate private sector demand which may have existed for decades, and has only been masked by a sequence of bubbles. The policy implication of this hypothesis is that generating adequate demand to ensure full employment in the future may require a permanent stimulus from the government – meaning both the Congress and the Fed – and perhaps the regular creation of asset market bubbles.

What could be causing the secular stagnation – if it exists? In Secular Stagnation, Coalmines, Bubbles, and Larry Summers, Krugman noted a couple of factors: a slowdown in population growth (which is obviously happening: see Figure 1); and “a Bob Gordonesque decline in innovation” (which is rather more conjectural).

Figure 1: Population growth rates are slowing

Though Summers’ thesis has its mainstream critics, there’s a chorus of New Keynesian support for the “secular stagnation” argument, which implies it will soon become the conventional explanation for the persistence of this slump long after the initial financial crisis has passed.

Krugman’s change of tune here is representative. His most recent book-length foray into what caused the crisis – and what policy would get us out of it – was entitled End This Depression NOW!. The title, as well as the book’s contents, proclaimed that this crisis could be ended “in the blink of an eye”. All it would take, Krugman then proposed, was a sufficiently large fiscal stimulus to help us escape the “Zero Lower Bound”:

Post-Summers, Krugman is suggesting that a short, sharp burst of government spending will not be enough to restore “the old normal”. Instead, to achieve pre-crisis rates of growth in future – and pre-crisis levels of unemployment – permanent government deficits, and permanent Federal Reserve spiking of the asset market punch via QE and the like, may be required.

Not only that, but past apparent growth successes – such as The Period Previously Known as The Great Moderation  –  may simply have been above-stagnation rates of growth motivated by bubbles. Krugman states:

This argument elevates the “Zero Lower Bound” from being merely an explanation for the Great Recession to a General Theory of Macroeconomics: if the ZLB is a permanent state of affairs given secular stagnation, then permanent government stimulus and permanent bubbles may be needed to overcome it. Per Krugman:

So is secular stagnation the answer to the puzzle of why the economy hasn’t recovered post the crisis? And is permanently blowing bubbles (as well as permanent fiscal deficits) the solution?