Servaas Storm: Secular Stagnation, Green Shoots or What?

By Servaas Storm, Professor, Department of Economics, Faculty TPM, Delft University of Technology and co-author, with C.W. M. Naastepad, of Macroeconomics Beyond the NAIRU (Cambridge, MA: Harvard University Press), which has just won the Myrdal Prize of the European Association for Evolutionary Political Economy

The Obama administration and the mainstream media are now talking up an imminent recovery, perhaps even a modest boom. Certainly, President Obama thinks so: “We head into next year with an economy that’s stronger than it was at the start of the year,” he said during his year-end news conference. “I firmly believe that 2014 can be a breakthrough year for America.”

We’ve of course heard this many times before during the past five years — and there is no reason why we should be optimistic now. For one, Obama’s optimism stands in sharp contrast to the gloomy spectre raised by former Treasury secretary and key White House adviser Lawrence Summers in speeches made at a Brookings-Hoover conference in October, and then again at an International Monetary Fund conference in November 2013.

Mr Summers fears the U.S. has entered a period of “secular stagnation” — a notion proposed by Keynesian economist Alvin Hansen back in the 1930s to explain America’s dismal economic performance—in which sluggish growth and output, and employment levels well below potential, coincide with a problematically low (even negative) equilibrium real interest rates even in the face of extraordinarily easy monetary policy.

Summers believes that the negative equilibrium interest rate is caused by the so-called Global Savings Glut—U.S. banks are said to be flooded by the inflow of Asian capital which supposedly depresses the equilibrium interest rate.

Initially Summers left the impression that not much could be done to get the economy out of this conundrum, even — somewhat guardedly — hinting at the need for another asset price bubble to restore growth. But in a Financial Times article of January 5, he has clarified his position, arguing that secular stagnation is not inevitable and can be undone by the right policies, essentially fiscal stimulus (in the form of public investment in “green” energy and infrastructure). It is encouraging that Mr. Summers is finally coming around to the realistic view, held by many Keynesians for long, that economic recovery will not come about spontaneously, and that the greatest threat to the recovery process now is Washington’s optimism which is lulling the administration into a false sense of security and fiscal inaction.

It is no surprise that Mr Summers’ analysis has stirred up strong responses on the political right. It is easy to predict that these reactions will become even more antagonistic after his recent “coming out” on fiscal stimulus. The tenor of these responses is quite predictable: the pitiful recovery must be blamed on government failure.

One prominent supporter of this view is Stanford economist John B. Taylor, a known partisan of efficient (financial) markets who had earlier argued that the Great Financial Crisis was triggered not by the bankruptcy of Lehman Brothers, but by the Bush-Paulson-Bernanke financial sector bailout. Hence, after blaming government for the crisis, the time has now come to blame it for the poor recovery as well. In a recent Wall Street Journal article, Mr Taylor acknowledges that the recovery of the U.S. economy from the Great Financial Crisis has been very slow and protracted, when compared to earlier episodes of recovery from (financial) crises. He agrees with Mr Summers that the cause(-s) of the stagnation need to be explained, but he rejects Summers’ “Global Savings Glut” explanation.

While Mr Taylor is right in rejecting the savings glut argument, it is rather unfortunate that he does it for the wrong reasons.

Mr Taylor actually misinterprets the “Global Savings Glut” hypothesis by arguing that the view implies that there should have been slack economic conditions (stagnation) and high unemployment already in the five years before the crisis, because excess foreign savings had been flowing into the U.S. economy and its banking system on a massive scale already then.

But his claim that the boom before the crisis cannot be squared with the savings glut argument is wrong. What he fails to understand is that in the years before 2007-8, the massive inflow of foreign capital — following the logic of Wicksell’s market for loanable funds — should have shifted the upward-sloping supply schedule of loanable funds downwards, while the downward-sloping loanable funds demand schedule (reflecting investment demand) remained unchanged. The result should have been a reduction in the equilibrium real interest rate, leading to higher investment.

However, once the crisis erupted full force, the loanable fund demand schedule must have shifted downwards (as profit expectations became depressed), and this created the situation, alluded to by Mr Taylor, in which “firms need an extra-low interest rate—even a negative interest rate—to be induced to invest. With interest rates at or near zero and inflation low, it is hard to get real interest rates down enough to provide these incentives.” This is the negative equilibrium real interest rate—the culprit identified by Mr Summers.

The second line of attack of the secular-stagnation thesis is Mr Taylor’s claim, perhaps surprisingly, that there has been no global savings glut at all. “In the past decade”, writes Mr Taylor, “global savings rates fell below what they were in the 1980s and 1990s. The U.S. has been running a current account deficit, which means national saving is below investment.” Well, Mr Taylor may be right (or wrong), but he is providing no evidence at all on this point. What he seems to be saying is that there has been no savings glut in the US economy. But he seems oblivious or unaware of the fact that the US current account deficit does imply — in a national accounting sense — an inflow of (excess) foreign or global savings.

But let us be clear. All this talk about the savings glut is a mere side-show. This is not at all Mr Taylor’s main point. What he seems to dislike most about the “negative equilibrium real interest rate” argument of Mr Summers is that it is lets “government get off the hook”. Mr Taylor begs to disagree. In his view, the poor recovery is due to weak business investment which is in turn “most likely explained by policy uncertainty, increased regulation, including through the Dodd Frank and Affordable Care Act, about which there is plenty of evidence”. Mr Taylor does not feel obliged to provide his readers with any evidence. He also does not feel any need to explain how “policy uncertainty” and “increased regulation” hang together and work out separately or in tandem. More regulation would appear to suggest that there is little uncertainty about policies, or put differently: how exactly do new regulations create policy uncertainty? “Policy uncertainty” falls into the same catch-all category as “business or investor confidence”: it is fundamentally un-measurable, it sounds very serious (notwithstanding or perhaps due to its vagueness), and it is always there. It is “an explanation of last resort”: if we can’t think of any good causes and don’t want to blame it on markets, then in that case we can always blame it on government creating “policy uncertainty” which in turn is undermining business confidence. This is, clearly, “Very Serious Talk”.

What is saddening about all this, however, is not just the narrowness of the debate between Messrs’ Summers and Taylor. Both are trying to come to terms (and unsuccessfully so) with the present weak recovery from mainstream economics’ positions — and in doing so, invoke 19th century theoretical constructs, such as Wicksell’s model of a loanable funds market, which were shown to be irrelevant for contemporary monetary economies long ago. But while Mr Summers is beginning to cautiously argue in favour of (actually: much-needed) fiscal stimulus, Mr Taylor continues to claim the economist’s privilege of social irresponsibility, rejecting stimulus and at the same time pinning the failure of (financial) markets on public policy.

What remains unstated in mainstream discussions is that the slow recovery and the looming secular stagnation is characteristic of economies suffering from a balance-sheet recession, as forcefully argued by Nomura’s Richard Koo as well as by many Keynesian economists. The key point indeed is that private investment is down (as both Messrs’ Summers and Taylor acknowledge), not because of “policy uncertainty” or “increased regulation”, but because business-sector expectations about future profitability have become dramatically depressed — and rationally so — in a context characterized by heavy indebtedness (of both households and corporations) and austerity.

Let the 1930s—a period of balance-sheet recession as well—provide some perspective. Roosevelt was no socialist, but his New Deal did frighten many businesses. That effect has to have been much bigger then than anything Obama ever did. But when public investment and hence aggregate demand expanded, the economy grew anyway. Roosevelt did have a vision and he did convince the electorate about the way to go. Cheap optimism or even audacity of hope will not be enough. After all, as Francis Bacon may remind us: “Hope is a good breakfast, but it is a bad supper” (Apophthegms, 1624).

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  1. armchair

    What a relief when Servas Storm writes off “loanable funds,” et al, as a side show as, “19th Century theoretical contructs.” With the very dumbed down version of Keynes that I am able to hold in my mind, it has alway felt to me that the Obama stimulus was a ‘band-aid for a shotgun wound.’ The Obama stimulus was insufficient and thereby gave Keynes-haters ammunition to claim that ‘stimulus doesn’t work.’ Now, we waste time waiting for the right combination of credentialed people to become sufficiently enlightened to finally act correctly. Talk about a lack of confidence.

    1. Tom Allen

      The Bush and Obama Administrations’ insufficient efforts at stimulus remind me of patients who take antibiotics for only half the prescribed time, justifying their actions “because I’m feeling better already.” This only results in a secondary infection that lasts much longer, as well as promoting the growth of antibiotic-resistant bacteria.

      1. NotTimothyGeithner

        Gee, I would have described it more as Obama promised “preventative” treatment without explaining “preventative” really just means diagnosis procedures and that the actual treatment would have to be out of pocket short of it being a complete disaster. Then even if you paid for it, Obama probably allowed incompetent clowns who caused the problem in the first place to administer the treatment and then passed tort reform, so you couldn’t even sue them.

    2. posa

      So can we agree that the bottom line agenda that arises after Storm’s deconstruction of Summer/ Taylor comes to this:

      1- Big write downs of inflated assets across the board to clear up balance sheets (corporate and household … even if this means closing or nationalizing insolvent mega-banks)

      2- Five trillion or more in stimulus funds? $1 T for student debt write down… $4 T for the Fed to buy state issued infrastructure bonds.

      This will work and is doable.

  2. craazyman

    This guy almost comes out and says it, openly, for everyone to read at their leisure: “Economics is a mental disorder.”

    C’mon Professor Storm, just say it! It’s OK.

    The reason it’s a mental disorder is because it recognizes the idea of quantity but not the idea of form. It only recognizes half of reality, and it thinks the other half takes care of itself if you throw quantity at it. That’s nuts. Why don’t they realize it’s nuts? Because they have a mental disorder. That’s why.

    1. NotTimothyGeithner

      At least American and American-influenced economists are no different than the priests from priest dominated societies. They defend the religion with arcane diatribes which had nothing to do with reality or even the original establishment in an effort to be a buffer between the wealthy and the rabble, and with a few notable exceptions, mostly when the economists defend and too much attention for outright lies, economists line up to defend their profession and “rivals” as wonderful human beings despite one set calling for policies which will devastate people’s lives.

      Obviously, it starts as a self-selective group as 18ish year olds.

  3. TarheelDem

    Savings glut = cash on the table not going into expanding productive workplaces, employment, and production. Just so we are clear about that obfuscation that disconnects symbols from reality. With labor considered pure cost to be shed, there is no demand for funds, no “entrepreneuers” willing to take those big “risks”. No Henry Fords and no unions.

    Taylor is not worth addressing. A shill is a shill is a shill. And Summers, who has gone through so many compromised revolving doors, is not worth addressing either–total lack of integrity.

    What the bailouts did was cash out a substantial portion of the phoney money created outside regulatory systems by credit default swaps and outright fraud, all of which was being captured on corporate balance sheets as if it were real. A credit default swap exposure of $100 T was wound down through providing enough assurances of non-default as to not continue the cyber-programmed panic.

    It’s not surprising that there are economists who still believe the fantasy of an economy without government in spite of the fact that there are structural reasons why it has never happened.

    It is really time to move on from the retrospective on six years ago and start formulating exactly what in practical terms infrastructure (the kind provided by social investments of government) means.

  4. Polly Cleveland

    Here’s a great opportunity to let Yves1 argue with Yves2. Yves1 writes, as she often has, “the slow recovery and the looming secular stagnation is characteristic of economies suffering from a balance-sheet recession …because business-sector expectations about future profitability have become dramatically depressed — and rationally so — in a context characterized by heavy indebtedness (of both households and corporations) and austerity.” Or, at greater length elsewhere,
    “Making money cheaper is not going to make anyone want to take risk if they think the fundamental outlook is poor. Except for finance-intensive firms (which for the most part is limited to financial services industry incumbents), the cost of money is usually not the driver in business decisions, Market potential, the absolute level of commitment required, competitor dynamics and so on are what drive the decision; funding cost might be a brake. So the idea that making financing cheaper in and of itself is going to spur business activity is dubious, and it has been borne out in this crisis, where banks complain that the reason they are not lending is lack of demand from qualified borrowers. Surveys of small businesses, for instance, show that most have been pessimistic for quite some time.” at
    On the other hand, Yves2 has written, with a passing nod to Yves1,
    “I’ve remarked in passing elsewhere that one of the reasons we don’t see more small business lending despite the Fed’s fond hopes that pushing on a string will work is that the overwhelming majority of banks no longer do small business lending. (The bigger issue is lack of loan demand, but we’ll put that aside for now). 30 years ago, every large bank had a year or two-long credit officer training program. They’d then cut their teeth working on large corporate loans and some would eventually wind up doing middle market lending or managing branches, which meant they’d approve small business loans. That type of officer has almost entirely died out. Except at small banks, branches sell products and loans are scored against templates set at high levels in the bank.

    Wait a moment. Why is lack of loan demand more an issue than credit-rationing by the banks? Banks complain about “lack of demand from qualified borrowers.” But who decides what are qualified borrowers? The banks!

    In the real world, there’s tons of demand from small borrowers, business and personal, whose very willingness to pay 24% on credit cards or much higher pawn-shop and check-cashing rates suggests they have very high returns on their small investments. All this is well documented in Abhijit Bannerjee and Esther Duflo’s Poor Economics. While, as they report, microcredit has been overrated as a solution to poverty, it can and often does raise the desperately poor to the level of merely poor—and that under far more disadvantageous conditions than those in the U.S.
    If there’s in fact tons of unmet loan demand, what can government do about it? First of all, obviously, break up the big banks. Since that’s not about to happen, how can government effectively get capital into the hands of desperate would-be borrowers? Any program that delivers cash or other benefits to low income people will help. That includes the Affordable Care Act. Imagine the impact of a set of dentures for a pain-wracked woman, afraid to smile for fear of revealing her black snags? Now she can apply for a job at Walmart! Programs that deliver free or very cheap education also help. Then there are jobs programs doing urgent high-return work, such as rebuilding city infrastructure. All this is the right kind of stimulus spending—as opposed to the wrong kind, like bridges to nowhere and military hardware.
    Yves1 and 2, are you there?

  5. hyperpolarizer

    What troubles me here is the discussion of economic law in terms of large abstractions, divorced from a human context. Economics, as a science, is distinguished by the inseparability of economic transactions and human volition. The economy we have is the one we have made, we in the large sense of human actors big and small, over the last few decades.

    The global stagnation we are experiencing is the logical result of Reagan-Thatcherism. The simple fact is that people don’t have money to spend, because the plutocracy has usurped the old post-war social contract between management and labor. Wages for the 99% in America have been flat in real dollars for 30 years –flat, that is, in real dollars as reckoned by the usual cost of living index. I have spoken with knowledgeable finance people who believe that real inflation in the US is running around 7%. In that scenario, the 99% lose even worse.

    The most significant economic news I have seen this week is that Boeing, in what was possibly a fraudulent election, has won from the Machinists’ Union the right to end defined benefit pensions for new workers, who will receive instead a 401k plan.

    This is not even a sick joke. Nor is it the result of abstract economic forces, but of power concentrated in the hands of the endlessly greedy. Multiply this by a million to get the current economic situation.

    1. rps

      “Economics, as a science…”Haven’t seen, heard or read about genome or atom splitting economic research. It’s more on par with wizardry; The great and powerful Oz pulling the inflation/deflation levers behind the curtain.
      Excuse my smirking about ‘economics’ as science. That sent me to the wayback machine of Bush in 2004 boasting new manufacture jobs were being created; that is to say McDonald’s hamburger flipping and garnishing was re-categorized as manufacturing; and ketchup and pickle relish were federally approved school lunch vegetables.

  6. backwardsevolution

    Yes, let’s throw fiscal stimulus (sugar) at cancer (all of the fraud) and hope it all works out!

    Until you clear up what went wrong, this will happen again and again (to the great delight of Wall Street/hedge funds), and we can all meet back here and call for more stimulus when it does.

    We had one great big party, and the party needs to be unwound. This will be painful, but over with quickly, instead of trying to hold the bubble up in the air to prevent it coming down.

    “Monetary Tectonics: The Tug of War Between Inflation and Deflation” – of course, it’s all artificially being held up by the Fed.

  7. gibby the fifth

    Having been an equity fund manager, where demand is a most important factor, it is clear that there is insufficient in the US at the moment. It is stirring in certain areas – fracking etc – but overall insufficient to encourage businesses to invest and banks to lend- they are always laggards and the big banks, as Yves has written, no longer have any feel for real business conditions – they are managed by Big Data. In the absence of any chance of a real fiscal boost from the government the only source of possible demand is an increase in the minimum wage. The Congressional Service (‎) has provided useful data on its movement since 1967 when it was 50% of average hourly earnings compared with 36% in July 2013. Corporate profits are at very high levels, inequality is extreme, the answer seems obvious to this observer. What I don’t know is how much of an impact this would make on the economy – perhaps somebody else can provide estimates?

    1. backwardsevolution

      gibby – raising the minimum wage is not going to help because before long the additional money just gets eaten up by Fed-induced inflation, and we’re back at square one again. It sounds good, though, doesn’t it? “Here’s your increase, sucker. Now go out and consume, increase demand, and push those prices up, you idiots.”

      The Federal Reserve is supposed to provide “stable” prices. “Stable” means “not likely to change or fail; firmly established.” If prices did not continue to rise, NO ONE WOULD NEED A RAISE!

      Corporate profits are at very high levels?

      “And there’s more. Take a look at the recent stock buyback frenzy, which is where companies buy their own stock to goose the price instead of investing in plants, equipment, hiring, or any other type of useful, productive activity. This is from Bloomberg:

      ‘Multiple expansion through share buybacks have been driving indeed the stock market higher greater than earnings have. …. Buybacks rose by 18% Quarter-over-quarter to $118 billion in 2013, up 11% year-over-year to $218 billion.’ (Bloomberg)

      Even so, Greenspan sees no bubble. Stock prices are based on good old fundamentals, like earnings. What could be more fundamental than earnings, right?

      Take a look at this from the Testosterone Pit:

      ‘Corporate earnings will grow this year at their lowest level since 2009. Revenue growth at public companies is almost non-existent. Companies are buying back stock at a record pace to boost per-share earnings.’ (“What Really Bothers Me About this Stock Market”, Michael Lombardi, Testosterone Pit)

      Huh? So earnings aren’t so hot either?

      Apparently not. And that means the fundamentals are actually weak, which makes sense since the economy is in the crapper.

      Then we ARE in a bubble, after all?

      Yep. And when it bursts it’s going to cost a lot of people a lot of money. Just like last time.”

  8. impermanence

    The ‘something for nothing’ train simply can not be derailed, as it has added nearly the entire population to its length.

    Be it government, corporations, welfare recipients, or private citizens seeking money for doing nothing what-so-ever [be it ripping-off patients/clients/customers, or engaging in the multitudinous forms of, “investing”], the economic system will continue its downward spiral until there is simply nothing left to steal.

  9. American Slave

    We are about to enter a profound change in advancement of automation and I could post a million links to videos of it but it would just be redundant.

    Having been at the front lines I can tell you that the promised future of everyone fixing and working on robots is not going to happen and even the biggest automation companies employ less than 10,000 people and they still use code mostly written in the 80s but with a few changes to the parameters.

    If there is an economic recovery that it will be the Starbucks McDonalds job economy (with an exception for the Momentum Machines hamburger making machine) so my advice to people who dont stick there heads in the sand is to hold off on that new car or house purchase.

  10. MaroonBulldog

    “Economics as a science.” The physics taught at MIT is exactly the same as the physics taught at the University of Chicago. The molecular genetics taught at MIT is exactly the same as the molecular genetics taught at the University of Chicago. Is the economics taught at MIT the same as the economics taught at the University of Chicago? If economics is a science, you’d think it would be, especially with Chicago professors like Goolsbee and Zingales holding MIT Ph.D.’s. But from what I’ve heard, it seems the economics is not the same at those two schools. Maybe I didn’t hear them correctly. I must be mistaken.

    1. hyperpolarizer

      “Economics as a science…” Alright, alright, I was just trying to be nice. My most recently published research article appeared in ‘Journal of Chemical Physics’, (not joking about that) — and, given the astuteness of the close-readers who populate the threads hereabouts, I hoped people would pick up that I was trying to finesse the question of being (at once) both ironical and polite (to economists).

      What strikes me most often about the thought of professional economists –such as I encounter it by following links to their writings, at places like economists– is the degree to which they are divorced from the commonsense practical world.

      Yes, I am a researcher at a Fortune 500 company; I am also a bench engineer whose solder joints (on special orders) wind up in customer laboratories.

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