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Stagnation?
Chapter 12
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Two possible sources of “secular stagnation” must be distinguished. The first source is chronically insufficient aggregate demand for goods and services; insufficient demand is demand that is less than the potential output of the economy. The second source is slow growth in the potential output of the economy. The US economy has only recently recovered from the Great Recession, so it is too soon to know whether it will suffer from secular stagnation.
If secular stagnation occurs due to chronically insufficient demand, a stimulus-without-debt policy that is applied as long as demand would otherwise be insufficient can keep actual output equal to potential output and therefore can achieve and maintain full employment (because potential output is defined as the output that would be produced in a given year if labor were fully employed in that year); every year, the level of output and employment would be equal to potential output instead of being below potential output. Also, as I will explain later in this chapter, keeping actual output equal to potential output each year can slightly increase the growth rate of potential output;
a stimulus-without-debt policy is unlikely, however, to significantly raise the growth rate of potential output.
Chronically Insufficient Aggregate Demand
For several years Lawrence Summers has contended that the United States and other economically advanced countries are likely experiencing chronically insufficient aggregate demand. In an article Summers (2016) provided an exposition of his case. He began by documenting the weak recovery from the Great Recession. The recession was not as deep as the Great Depression, and recovery began sooner because aggressive fiscal stimulus was applied sooner (Summers helped shape and enact the fiscal stimulus as a top economic adviser to President Obama in 2009); but the recovery has been slower than usual in a recession, so that, like the Great Depression, the Great Recession has generated a “lost decade.”
Summers noted that the term “secular stagnation” was introduced in 1938 by Harvard’s Alvin Hansen, a recent convert to Keynes’s perspective, who contended that changing demography and an exhaustion of investment opportunities would generate a chronic insufficiency of aggregate demand. In Summers’s view, Hansen was wrong about the next few decades after 1938 due to military spending during World War II, the release of consumer demand after the war that had been pent up during the war, and demand due to massive suburbanization (for example, for highways, automobiles, and housing).
Summers said, however, that Hansen’s thesis appears to be correct for the first two decades of the 21st century, because despite very low interest rates that should stimulate borrowing and spending, actual GDP has continued to remain below potential GDP and actual inflation has remained below the target of 2%. Consumer demand has been too low because increasing inequality
has raised the share of income of the rich, who have a lower propensity to consume than the nonrich. Investment demand has been too low because slow growth of population and labor force has reduced demand for housing and plant and equipment. The economy temporarily had enough demand from 2003 to 2007 only because of unsustainable borrowing by consumers. If slow growth were due to supply, not demand, interest rates and inflation would be high; instead, both are low, supporting the hypothesis that it is demand, not supply, that has caused the slow growth in output.
Summers warned that when the next recession occurs, monetary policy will be unable to cut interest rates because interest rates are already near zero. Hence, there should be a radical rethinking of the role of fiscal policy in economic stabilization. With monetary policy able to do much less, fiscal policy will need to do much more. Summers assumed that fiscal stimulus must involve deficits and debt, but argued that it is worth incurring these deficits and debt. With interest rates chronically low, even large debt burdens can be safely incurred, and should be incurred in order to get the economy to grow.
I agree with Summers that even if the Treasury had to borrow to finance fiscal stimulus in a period of chronically insufficient demand, Congress should enact sufficient fiscal stimulus every year and instruct the Treasury to borrow to finance it. I also agree with Summers’s point that with interest rates very low and construction workers still suffering high unemployment, it makes sense to borrow to fund repairs to school buildings and airports.
The problem with Summers’s proposal to borrow to pay for fiscal stimulus is that many will continue to oppose fiscal stimulus if it involves deficits and debt. One purpose of this book is to show that fiscal stimulus does not have to involve deficits and debt. I applaud Summers for making the case for ongoing fiscal stimulus if the US economy ever suffers from chronically insufficient aggregate demand. But he should recognize that ongoing fiscal stimulus can be provided without deficits and debt.
Slow Growth in Potential Output
Indirectly, a stimulus-without-debt policy, by keeping actual output equal to potential output, should generate a slightly higher growth rate of potential output. With actual output kept equal to potential output, each year the level of investment, including research and development, would be slightly higher than it otherwise would have been. A slightly higher level of investment and R & D each year should result in a slightly higher rate of technological progress—a slightly higher rate of introducing new production processes and new goods and services—and thus, a slightly higher growth rate of potential output.
A stimulus-without-debt policy, however, is unlikely to generate a large increase the rate of technological progress and therefore is unlikely to significantly increase the growth rate of potential output. There is a vast literature on the causes of the rate of technological progress and policies that may be able to significantly raise that rate. These policies are supply-side, not demand-side, policies. For example, incentives that result from public policy for patents and property rights in new inventions, or from the tax treatment of R & D expenditures, may have a significant impact. Some periods of history, however, may simply be more conducive to generating increases in the rate of technological progress, and other periods less conducive.
Conclusion
Stimulus without debt can combat secular stagnation if the cause of the stagnation is insufficient demand. Stimulus without debt—tax rebates to households and transfers from the Federal Reserve to the Treasury—can and should be implemented for as long as the demand-induced stagnation lasts. Without the
transfers from the Fed to the Treasury, the necessary fiscal stimulus would cause debt to rise to a very high percentage of GDP, rightly causing concern and resistance to the fiscal stimulus. Stimulus without debt would solve the insufficient demand problem without causing a serious government debt problem.
If the stagnation is caused by slow growth of potential output, stimulus without debt can make only a modest improvement. By raising aggregate demand, stimulus without debt can keep the level of output and employment each year as high as possible without generating a rise in inflation; with investment slightly higher than it otherwise would have been each year, the level of the capital stock and technology should be slightly higher and the growth rate of potential output is likely to be slightly higher than it otherwise would have been.
Thus, if secular stagnation is due to a slow rate of technological progress, a stimulus-without-debt policy can provide a little help. If secular stagnation is due to chronically insufficient demand, however, stimulus without debt can provide a lot of help.
