Secular Stagnation: Natural Rate or Structural Change?
December 15 I attended INET’s day-long workshop on Secular Stagnation, and I meant to write about it at the time. But life intervened, then holidays, then the “bomb cyclone”, until this morning when Twitter drew my attention to the multiple sessions on the topic that are running this weekend at the annual ASSA meeting. Better late than never.
On this topic, I start from Alvin Hansen, who originated the term “secular stagnation” in his 1938 Presidential Address to the American Economic Association, “Economic Progress and Declining Population Growth”. If you haven’t read his speech, you should. Hansen of course knows nothing of modern DSGE or OLG models, and so is completely unconcerned with the technical challenge of getting those models to produce a negative equilibrium rate in the absence of a zero-lower bound. But he does know about the actual American economy, and the lived experience of the Great Depression, and he clearly feels the obligation as President to speak to that experience.
In the second paragraph of the speech Hansen frames the problem as he sees it:
“The economic order of the western world is undergoing in this generation a structural change no less basic and profound in character than that transformation of economic life and institutions which we are wont to designate loosely by the phrase “the Industrial Revolution”. We are passing, so to speak, over a divide which separates the great era of growth and expansion of the nineteenth century from an era which no man, unwilling to embark on pure conjecture, can as yet characterize with clarity or precision. We are moving swiftly out of the order in which those of our generation were brought up, into no one knows what.”
For Hansen the problem was most emphatically not a mechanical failure of investment to equal savings at a positive rate of interest in a static model of economic equilibrium. “Yet few there are who believe that in a period of investment stagnation an abundance of loanable funds at low rates of interest is alone adequate to produce a vigorous flow of real investment.” The problem rather was one of structural change.
Economic history demonstrates, says Hansen, that the ability of our market economy to achieve full employment has always depended on robust investment spending. In the past there have been three strong drivers of such spending—population growth (immigration and natural increase), technological innovation, and availability of new territory (colonies and frontier). Today, however, moderation of population growth and closing of the frontier leave technological innovation as the sole autonomous driver of investment, and we are learning that it is not enough. New technologies have their impact only when they spawn new industries, but weak aggregate demand is creating inhospitable conditions for such. The result is stagnation.
The answer, for Hansen, was in part “income-creating government expenditures” to support a basic floor of aggregate demand (i.e. fiscal policy), but more fundamentally embrace of the dual economy, part public and part private, with government serving as investment bank. The whole point of the former was to support traverse to the latter, which would inevitably take time.
“Governments all over the world are in the process of becoming intermediaries between the ultimate savers and investment outlets, but the process of production is still carried on by private enterprise. This is neither socialism in production nor even in the ownership of wealth. The government is becoming an investment banker” (Hansen 1938). “In place of our 19th century western frontier we can, if we look for it, find and develop a great new frontier in our own backyard” (quoted in Mehrling 1997, p. 120).
The dual economy was Hansen’s own “pure conjecture” about a possible destination for the traverse that he identified as the fundamental challenge confronting his generation. Hansen’s value for the present debate is his framing focus on the challenge of the traverse that now confronts our own generation. “We are moving swiftly out of the order in which those of our generation were brought up, into no one knows what.”
Hansen, Alvin H. 1938. Full Recovery or Stagnation? New York: Norton.
Hansen, Alvin H. 1939. “Economic Progress and Declining Population Growth.” American Economic Review 29 No. 1: 1-15.
Mehrling, Perry. 1997. The Money Interest and the Public Interest. Cambridge, Mass.: Harvard University Press.