Secular Stagnation: The Limits of Conventional Wisdom

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By Stefano Di Bucchianico, Visiting Professor, Free University of Berlin. Originally published atthe Institute for New Economic Thinking website

Summers and Stansbury mark a dramatic shift from New Keynesian orthodoxy, but only make it halfway to understanding the demand-driven nature of stagnant growth

Stagnation and inequality have been, for a long time, topics reserved to heterodox economists. Then came the Great Recession, and the term Secular Stagnation started to trend. In particular, Larry Summers (2014) stressed the possibility that advanced capitalism was facing long-term stagnation, echoing Alvin Hansen’s worry (1939) in the aftermath of the Great Depression, and a fervent discussion started to take root inside the academic community. But a recent break within the New-Keynesian consensus, put forward by Summers himself, has now triggered a new wave of debate.

The Neoclassical New-Keynesian take on Secular Stagnation has been grounded in the difficulties monetary policy faces in trying to hit the natural interest rate (the rate at which savings and investment are equal at full employment) when the latter turns negative. This Zero Lower Bound constraint makes it difficult for central banks to move the policy-controlled nominal interest rate low enough to reach the interest rate that in theory ensures full employment. Normally, the presently scant inflation and output below potential would signal to central bankers the need to lower the interest rate (a behavior usually summarised via the famous ‘Taylor Rule’, Taylor 1993). However, if the policy-controlled nominal interest rate is already zero or very close to it, these mechanisms cannot work properly, and the economy comes to a standstill. Monetary policy eventually becomes powerless, with even extraordinary monetary measures such as quantitative easing failing to boost growth.

This basic intuition has later been elaborated in more complex analytical models (Eggertsson et al. 2019), which find an explanation for this condition in a mix of elements, such as aging population, slower technological progress, rising income inequality, and households deleveraging.

Last summer witnessed a harsh discussion between Stiglitz and Summers himself, in which the former buttressed the case for pure and simple fiscal policy to revive aggregate demand and employment. The same argument was previously brought forward by Girardi et al. (2018) and Cynamon and Fazzari (2017). One year later, Summers appears to progressively be moving towards the direction hinted at by these authors. Indeed, Summers and Stansbury have recently gone back to the topic, offering what can be considered a major break with the New-Keynesian perspective on growth and stagnation. In an even more radical move, the authors reveal their increasing skepticism about conventional policy discussions, since they “are rooted in the (by now old) New Keynesian tradition of viewing macroeconomic problems as a reflection of frictions that slow convergence to a classical market-clearing equilibrium.” This shifts them from “progressive” neoclassical positions to those somewhat closer to a long tradition of economic heterodoxy. Accordingly, citing Palley (2019), they argue that “the role of particular frictions and rigidities in underpinning economic fluctuations should be de-emphasized relative to a more fundamental lack of aggregate demand,” hoping economic policy will in the next future be informed more by ‘Old Keynesian economics.’

This means that the Zero Lower Bound is not responsible for hampering healthy monetary policy, thereby bringing about stagnation. Similarly, underemployment, which is what we see in the US right now, does not emerge because firms are slow and reluctant in adjusting their menu prices, employers pay an inefficient wage to avoid workers’ shirking, or because interest rates cannot fall enough (all examples from the New-Keynesian arsenal) (Fontanari et al. 2019). Instead, scholars and policymakers should recognize that the culprit lays in a lack of demand for products and services, which in turn slows down growth and curtails employment.

It is difficult to overestimate the importance of those openings with respect to the role of aggregate demand in determining not only current economic performance (something which is not alien to New Keynesian economics), but also growth and employment trends. All the more so if these claims are accompanied by a forceful rebuttal of the role of monetary policy vis-à-visfiscal crackdowns operated by governments. Given the constructive way in which Summers and Stansbury are looking anew at the matter, I would like to raise some additional theoretical and practical points and provocatively ask them whether they be willing to accept Post-Keynesian perspectives on growth, employment and income distribution.

‘Old’ Keynesian scholars, indeed, have always been partial to demand-side fiscal policies and very critical of the concepts of natural interest rate and loanable funds. Why and with what political (more than policy) implications?

Let us start with monetary policy. While it is very plausible that ultra-low or even negative nominal interest rates can severely damage the financial system (Rossi 2019), Post-Keynesians stress the broader point that monetary policy is generally incapable of stimulating the economy. Keynes (1936) himself emphasized that equality between savings and investments is brought about primarily via changes in income levels, with the interest rate left in an altogether secondary position.[1] This would become especially visible in a “liquidity trap,” but remains true also outside it, contrary to what the successive Neoclassical Synthesis started to argue (Hicks 1937, Modigliani 1944). The underlying reason is that the effect of interest rates reductions on private business investment is usually mild, that the role of aggregate demand growth can be expected to be of superior importance, and that public deficit spending can better stimulate demand, as we will discuss (Chirinko 1993, Chirinko et al. 2011).[2] Therefore, the however fundamental critique of monetary policy effectiveness applies, regardless of the course of actual interest rates (Rochon and Setterfield 2007, Seccareccia and Lavoie 2016).

Here we have a first instance in which the so-called ‘Old Keynesian’ principles come in peculiarly handy. But there is more to the story.

Secular Stagnation has been hitherto addressed by referring to the decline of the natural interest rate, eventually to the negative territory. Summers and Stansbury mention (without expanding on the argument) the possible non-existence of such a rate. However, they do not expand on the argument, which by the way stands in contrast with what Larry Summers was stating in those very same days in a NBER paper co-authored with Łukasz Rachel (2019).

On the contrary, on this point, the Post-Keynesian view is very clear and established. The use of the natural interest rate determined by the marginal productivity of capital (and of an equilibrium real wage given by the marginal productivity of labor) has long been known as difficult to defend, after the criticism related to the “Cambridge capital controversies” (Lazzarini 2011, Fratini 2019) spurred by the contributions of Joan Robinson (1953) and Piero Sraffa (1960). Even besides this fundamental criticism, the natural interest rate concept relies on a loanable funds schema, according to which prior available savings are necessary to fund investment. This idea presents several theoretical and empirical problems, and leaves financial authorities in serious predicaments. Indeed, the natural rate estimates have been subject to a slew of criticisms (Levrero 2019) and its theoretical applications have been proven not to fit the available empirical evidence on savings and investment (Taylor 2017). In addition, the concept gets all the hazier when such an interest rate takes up negative values, which are hardly compatible with a Neoclassically-determined equilibrium position (Di Bucchianico 2019).

Why then do Summers and Stansbury hesitate at recusing the concept? Getting rid of it entirely carries significant policy consequences, which may explain this behavior. In fact, the existence of a natural interest rate toward which the real rates should tend to converge, thus guaranteeing full employment, implies the conclusion that underemployment emerges when there is some rigidity that hinders that convergence. This for example compels policymakers to call for nominal wage cuts when there is (involuntary) unemployment, given that the latter cannot but result from an insufficient fall of the real wage.

Indeed, let us then come to the actual policies, for example Trump’s tax cuts. Certainly, we cannot pin on the reform, or on any taxation plan, the prolonged trend of rising inequality afflicting the United States; however, it adds to it. What is more, an IMF paper has recently shown that the cuts have had, in line with “Old” Keynesian predictions, a secondary role in spurring US investment growth, the bulk of the effect coming from aggregate demand expansion (Kopp et al. 2019).

The objection of New Keynesian scholars to this policy thus far concentrates on its effect on the value of the natural interest rate, rather than on the overall socio-economic environment (including the evolution of aggregate demand). Indeed, in that line of thought, the additional flow of savings from top income households adds, for an unchanged demand for investment, to the supply of loanable funds, thereby lowering the natural rate of interest. In their view, if this dynamic happens in “normal” state of the world, there would be basically no problem for the central bank to appropriately lower the policy-controlled interest rate down to match the natural interest rate drop. In fact, that has been the policy for the whole period of the Great Moderation, when wage repression has caused inequality to rise and the savings of the rich to increase thanks to rising indebtedness. As we know, this eventually became a wide-spread problem when the financial crisis erupted and the attempt by households to deleverage hampered aggregate demand.

Hence, within that framework the preoccupation rests on the possibility for monetary policy to correctly work (Di Bucchianico 2019). Getting the causal direction straight is important to put inequality at the forefront of our economic—but also, social and political—problems, and not just pull it out of the hat when the situation becomes unmanageable (Ferguson et al. 2018, Storm 2017). Failing to do so considerably impairs the possibility to look in a satisfactory way not only at the plea of real-world phenomena which can trigger stagnation, something “Old Keynesianism” may instead do (as in Hein (2016), Skott (2016), Serrano et al. (2019), Taylor (2020)), but also at the possibility to foster increasing economic wellbeing for all, as a permanent policy goal.

Hence, if there is a point of contact between Post-Keynesians and Summers and Stansbury, that is the acceptance of a demand side explanation of the current stagnation, regardless of the presence of price rigidities.

This opening, given the circumstance, is remarkable and should be welcomed, but its authors are still halfway the road.

[1] Among many others, Chick (1992), Lavoie and Seccareccia (2004), Smithin (1989, 2004) have applied these clues to modern economic policy conduct.

[2] What is more, adamantly relying on monetary policy can obscure the fact that many times the latter is not only ineffective, but can be detrimental to many layers of the population, especially when households are still facing the consequences of an abrupt deleveraging episode.

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  1. Chauncey Gardiner

    Not to diminish the overriding importance of domestic federal spending that improves the lives of ordinary citizens and the long-term health and economy of the nation, but in my view there is a vital missing piece from this discussion in addition to the quiet oppo of so many economists and politicians for the true policy elite to abandon their support of fiscal austerity and low, even negative real interest rates despite the evidence. That missing piece is the quiet elevation to primacy of the role of the financial and real estate markets in creating what they view as a “virtuous cycle” of mutually supportive and ever-increasing levels of private sector and monetarily non-sovereign government debt; ever-increasing asset prices; and ever increasing concentration of wealth and economic power in the hands of a few that translates into the political inequality which solidifies their control. The unrelenting efforts of the federal government, its central bank, Wall Street and the economic elite to engineer this debt-based feedback loop that ultimately results in asset price bubbles, done under the guise of recreating a “Wealth Effect” to increase consumer demand, at least until the inevitable Minsky Moment occurs, is coldly intentional.

    1. notabanktoadie

      for the true policy elite to abandon their support of fiscal austerity and low, even negative real interest rates despite the evidence. Chauncey Gardiner

      Low interest rates are good IF they are produced ethically by, say, an equal Citizen’s Dividend and not welfare for the banks and the rich.

      And the MOST inherently risk-free debt of monetary sovereigns, including account balances at the Central Bank, should return is ZERO percent. Otherwise we have welfare proportional to account balance, i.e. for the rich.

      And while individual citizens should be shielded from negative interest on their (not yet allowed) accounts at the Central Bank up to a reasonable deposit limit as a normal right of citizenship, other accounts should have no such exemption and SHOULD be charged negative interest to, for examples, discourage fiat hoarding and, in the case of banks, to eliminate their free use of the Nation’s fiat for their own benefit and for the rich, the most so-called credit worthy.

      But yes, austerity is dumb for monetarily sovereign nations.

  2. Tom Pfotzer

    Our global productive capacity has outrun our global ability to buy the fruits of production, and to keep that productive capacity running strongly enough to pay the workers and capitalists enough to keep the hamster wheel spinning.

    Capitalists are (currently) doing fine; they’re getting the larger share of the fruits of production. But if they don’t share those fruits, the laborers can’t afford to buy, so demand starts to fall off. The capitalists are not eager to share, but that’s only part of the problem.

    The bigger problem is globalization (much expanded labor pool for common manufactures) and automation (massive wringing out of labor from production equation). The value of labor is falling world-wide. Labor is what most of us sell. No wonder our capacity to buy is diminishing.

    For the past 50 years here in the U.S., we’ve boosted aggregate demand with deficit spending, funded by borrowing. Wars (“defense”), transfer payments (SS, food stamps, school lunches, farm subsidies) have all done the work of transferring money to households that will immediately spend it.

    But now we’re running out of borrowing power; who will buy our debt? That is a very big question, and a very timely question.

    If we stop the borrowing, the resulting reduction in “aggregate demand” will be wrenching, and may cause a depression if it gets into the feedback loop of workplace close -> hh income reduction -> further reduction of demand -> workplace close…etc.

    That is the specter looming over our Federal Gov’t, the Fed, and every other major central bank. What are the choices?

    Redistribution. Take wealth from wealthy, give it to households to spend
    Repression. Tell them to eat cake, and use spying & police to enforce
    War. Destroy other nations’ productive capacity. WWII redux
    Redistribute wealth-generating capacity. Level the capacity to create wealth, rather than leveling the possession of wealth*

    And all this is happening in a backdrop of “the planet can’t handle a lot more production**”.

    We humans have a great deal of adapting to do. Seems like there’s a lot more talk and arguing than adapting.

    * Doesn’t have to be the dreaded communism. Education, massive incease in small biz formation, etc.
    ** As we currently perform production. There are alternatives.

    1. False Solace

      > For the past 50 years here in the U.S., we’ve boosted aggregate demand with deficit spending, funded by borrowing.

      Deficit spending doesn’t fund borrowing at the federal level. This is why the refusal to engage in monetary policy is so myopic.

      We know that low interest rates aren’t enough to end economic stagnation: we need more aggregate demand. So where is this demand to come from? The private sector can’t increase its spending because it’s already swimming in debt. Think stock buybacks, LBOs, and student loans. Some countries look to generate demand by increasing their exports. But in the US, the trade deficit means that existing demand is transferred to China. (That must be what’s in all those empty shipping containers.) The only thing left is the public sector. State and local governments are strapped, but thankfully the public sector doesn’t have meaningful constraints on borrowing at the federal level. The ECB and BOJ already buy government debt, the Fed can easily do the same. All that is needed is the political will to engage in monetary policy.

      Tax cuts for billionaires and billionaire corporations haven’t done much to stimulate demand. The last resort is war so let’s hope for the second-to-last resort instead: spending which actually ends up in the pockets of the public.

      1. John Zelnicker

        @False Solace
        October 2, 2019 at 5:34 pm

        The Fed already owns $2.38 trillion of Treasury securities out of about $21 trillion outstanding, Social Security and federal pension funds own another $5.73 trillion. IIRC, the Fed recently held as much as over $4 trillion.

        The purchase by the Fed of Treasuries held by the non-government sector does nothing to increase aggregate demand. It is simply an asset swap, a non-interesting bearing security (currency) for an interest bearing security (Treasuries). This is also known as Quantitative Easing (QE) which the Fed did for many years. Didn’t help a bit.

        As the article says, we need more government spending, i.e., fiscal policy.

        1. Yves Smith Post author

          This is completely false and you need to stop propagating this misinformation. I’m not very tolerant of this sort of thing because we’ve devoted numerous posts to this topic.

          Go read Randy Wray’s Understanding Modern Money and get back to me.

          The Treasury spends by debiting its account at the Fed. Bond issuance is a convention.
          The deficit ceiling is a political constraint and has nothing to do with operations.

          Bernanke, Greenspan, former Treasury official Frank Newman and the Bank of England have all contradicted your claim. So please do not persist.

          Here is one of many explanations:

          If you think about it, central banks, in addition to conducting monetary policy and engaging in asset swaps with the non-government sector, directly purchase goods and services from the non-government sector.

          They buy things like office supplies, IT and other equipment including professional services and training, building maintenance services, and other items that are use to equip, train and provide for their operations and staff.

          Large purchases usually require competitive tender situations. But that does not abstract from the reality – these purchases are equivalent to the treasury department buying goods and services from the non-government sector.

          Where do the funds come from to facilitate these purchases? From the currency-issuing capacity of the ‘government’. The central bank would just credit bank accounts in favour of these orders and create bank reserves ‘out of thin air’.

          This is a different operation from quantitative easing where no new financial assets are created in the non-government sector. QE just allows the non-government sector to alter its portfolio of financial assets – less government bonds (for example) and more bank reserves.

          In both cases the wherewithal comes out of ‘thin air’ but the impacts on the net financial position of the non-government sector is different.

          In the case of direct central bank purchases of goods and services, no tax revenue or debt issuance would be required. In doing so, new net financial assets would be created in the non-government sector and we would not think for one minute that the ‘spending’ was made possible by tax revenue or borrowing from the non-government sector.

          When talking about the treasury department, things seem to get more complicated because there is an array of these accounting processes that give the impression to those who do not really understand the abstraction involved that tax revenue and funds raised by selling debt provide the ‘money’ which allows the treasury side of government to spend.

          But, the reality is akin to the central bank purchases and the accounting arrangements are just smokescreens designed to present a false causality.

          The government deficit (treasury operation) determines the cumulative stock of financial assets in the private sector. Typical decisions taken by the central banks, then determine the composition of this stock in terms of notes and coins (cash), bank reserves (clearing balances) and government bonds with one exception (foreign exchange transactions).

          Any payment flows from the government sector to the non-government sector that do not finance the taxation liabilities remain in the non-government sector as cash, reserves or bonds.

          Note the causality here – the government finances the taxation revenue.

        2. Tom Pfotzer


          I meant to say def spending financed by Fed Govt borrowing, not Fed Reserve.

          But this line of your post “The Treasury spends by debiting its account at the Fed. Bond issuance is a convention” suggests that I still don’t have it right, and need to read more.

          So: sorry for not contributing to the “be precise and correct” ethos here at NC.

          I will indeed do pennance by reading Randy Wray’s book.

    1. JBird4049

      Even a busted clock has to be right twice a day, no? And those Harvard degrees of his must be doing something good. :-)

  3. nothing but the truth

    a job is basically access to resources (excepting some jobs like consulting, IT, finance – which is what the politicians keep pushing because they know that the problem is resources, not just govt spending).

    the system has to ensure that resources are not held on to by rent seekers and other asset strippers, ie, resources are recycled.

    at the moment the system encourages leveraging and holding on to assets as that is the only way to ensure that purchasing power of funds does not disappear.

    and btw the deficit has been soaring lately. supposedly unemployment is very low. my 22 year old cant get one call for an interview. smart kid, STEM degree.

    The only place that showed some warmth was a pizza hut, which wouldn’t even produce insurance for the delivery vehicle.

    1. JBird4049

      which wouldn’t even produce insurance for the delivery vehicle.

      Wait, what? I have never heard of such a thing. I am going by California, so in the other forty-nine states I could be wrong, but…it does not matter who is driving the vehicle, if the company owned delivery vehicle while be driven by the company employee gets into the accident, the company is going to get nailed. I’m sure the driver is on the hook as well, especially if he is at fault, but the cheapskates with the money are the ones that are going to get nailed.

      1. inode_buddha

        Here in NY, you use your own vehicle (and registration, and insurance) for pizza delivery and get some pittance like 10 cents a mile on top of a pitiful wage. The math barely breaks even.

        1. JBird4049

          Ow, I guess I learned something today. 10¢ per mile? That’s whacked. I was getting that when gas was last under a dollar a gallon. So, no the math does not even break even.

  4. chuck roast

    ‘Old’ Keynesian scholars, indeed, have always been partial to demand-side fiscal policies and very critical of the concepts of natural interest rate and loanable funds. Yes indeed. The only problem with us old Keynesians is that we viewed Military Keynesianism as a sop for the obvious possibility of abundance. Militarism had a nice way of creating scarcity…if we got lots of tanks and battleships for which there is no demand, then we can create a nice equilibrium for the aggregate demand of refrigerators and autos. We will go to hell for that.

    Summers and Stansbury mention (without expanding on the argument) the possible non-existence of such a (natural interest) rate. However, they do not expand on the argument. Yeah, it was a scream when Phelps won the Nobel Prize for developing “the natural rate of unemployment”…after it had been disproven. Ya’ gotta’ love those “natural rates”. They are so soothing and seemingly normal. Of course there is a complete lack of credible evidence for “natural rates”…but, since when did that ever stop a Classical Economist or for that matter the Nobel Committee.

    And of course we always have to consider “price rigidities”. These can be explained by the conversation I had with my wife today:

    Wife: “So, I was reading that they are having a lot of difficulty hiring truck drivers.”

    Roast: “The difficulty would probably ease if they paid the guys a living wage.”

    1. JBird4049

      Whenever I read interviews and quotes of business owners and CEOs complaining of not being able to hire enough people, especially after hearing what they are offering, it feels like the lord of the manor is complaining about the serfs actually wanting to get something other than hunger and want, why the sheer gall of them!

      I am going a little off tangent, but those words of our modern employers sounds much the same as those quotes I have read from the English and French nobility right after the Black Death when the workers were demanding higher wages being as half of the them had died creating a labor shortage.

      Much of the economic writing of the last fifty years seems to be more like liturgical works supporting the presumed natural order of things, the current hierarchy of our society, rather than actual studies and rational explanations on how economies works.

      So one complains about underemployment and of the priests whips out a text from the sainted Chicago Boys and it’s all revealed as a lack of education, or intelligent, or willpower, and not through any fault of the current system.

      1. Amfortas the hippie

        drove mom the 80 miles to kerrville and back the other day.
        on highway 16, passed the handful of obviously well financed wineries…sprawling estates, composed of the spreads of former peach growers and ranchers who got land rich, cash poor(due to monopoly/globalisation in ag sector(=argentine beef/chinese peaches preferred by mr market)), and sold off their legacy because they couldn’t pay the tax man.(these settler descendants and those of their progeny that stayed are now clogging the retail/service job market…often well into their 70’s)
        llc’s and other egregores swooped in and scooped them up when the texas wine “industry” looked like a thing.(*)
        there were workers… fixing fence, trimming vines, laying pipe and mowing around the grand gates….every one of them a lovely brown.
        a search of facebook, etc reveals that the proprietors/managers(who knows who actually owns these estates) are near the most vocal end of the anti-immigrant/hatred of brown people movement…and they all love trump.
        the disconnect is astounding.
        I see things like this regional winery thing as a microcosm of broader trends at the tippy top…they’re trying to recreate feudalism/manorialism…but with wifi and electric cars and tomatoes in january(for them). most of the estates, today, are abstractions, of course, and not as obvious as these actual physical estates.(can’t put yer hand on blackrock or exxon…they exist on another plane)

        (*in contrast, the small vineyards and wineries hereabouts are struggling…overleveraged and weary(per,a look at the vines/landscape, as well as the number of people visible out there working).
        if one is paying attention, it’s perfectly obvious who has access to Finance….the tattered vines and weeds….as well as the idle wine tour buses, and the empty B&B’s…tell the tale.
        of course, this “industry” was doomed from the get-go—-their audience/market is the upper portion of the middle class…those with enough discretionary income to take a vacation in the texas wine country. this is exactly the cohort that is currently shrinking and falling down into the lower orders.)
        all this plugs easily into the matrix documented, for just the most recent thing ive read, the matt stoller article, yesterday.

  5. TG

    Hmm. But perhaps one might consider that all of these noted scholars are at best fools and useful idiots if not actual deliberate intellectual whores and traitors?

    Why should we pay any attention to all of this complicated rot? I mean, if an engineer who was involved in a successful deep-space mission talks about a technical matter, I will pay attention, even if at first it’s hard for me to follow.. If these wrong-way Corrigans of economics spin ever more complicated esoteric theories, so what?

    Think about NAFTA and MFN for China. The United States shipping its industrial core to foreign countries, and in China’s case, at least a major competitor if not an enemy. Look how that worked out. These ‘economists’ swore on a stack of bibles that this would be wonderful, that America would get all these great new jobs, yada yada. They swore that American companies would not ship their factories overseas. That Americans would not lose their jobs. That Mexico would become rich and illegal immigration would stop. It was all a lie, wan’t it? And why should we listen to any of these monsters now?

    Before diving into the arcana of Neo-classical-liberal-anarco-fusional-vegan economics, perhaps ask, have any of these people come up with any theories with any real-world predictive power?

    1. inode_buddha

      What matters is not whether WE listen to them, what matters if billionaires and decision makers listen to them. And they certainly did, they liked what they heard, and then acted upon it. No skin off their backs, no downside — all upside as far as they can see.

  6. notabanktoadie

    The debate over secular stagnation continues, yet orthodox economists are loath to admit that the needed fix is more demand, which means more government spending.

    Except the government does not necessarily have to be doing the spending, i.e. an equal Citizen’s Dividend would leave spending decisions to individual citizens.

    Not only that but arguably ALL fiat creation beyond that created by deficit spending for the general welfare should be in the form of a Citizen’s Dividend to avoid violating equal protection under the law.

    Not only that but how much less might be objections to eliminating boondoggles, such as excessive military spending, if the savings were to be applied, at least partially, to a Citizen’s Dividend?

  7. Sound of the Suburbs

    Secular stagnation / the new normal / Japanification

    Japanification of the global economy is nearly complete.

    Australia and Canada are just doing it now.

    Japan was the first nation to really blow its economy up with a real estate boom and they have been paying the price ever since.

    At 25.30 mins you can see the super imposed private debt-to-GDP ratios.

    What Japan does in the 1980s; the US, the UK and Euro-zone do leading up to 2008 and China has done more recently. This is why we have been having such trouble with growth ever since.

    Richard Koo had studied what had happened in Japan and knew the same would happen in the West after 2008. He explains the processes at work in the Japanese economy since the 1990s, which are at now at work throughout the global economy.

    Debt repayments to banks destroy money, this is the problem.

    Japanification – Come on in, the water’s fine.

    Actually, Japan’s decades long stagnation was the result of it being able to trade and export to other healthy economies.

    Now everyone is in a bad way, “Japanifcation” will be a whole lot worse.

    1. Sound of the Suburbs

      Why does neoclassical economics cause this to happen?
      They used neoclassical economics in the US in the 1920s and got the same thing.

      1929 and 2008 look so similar because they are; it’s the same economics and thinking.

      Richard Vague has analysed the data for 1929 and 2008 and they were even more similar than they initially appear.
      Real estate lending was actually the biggest problem in 1929.
      Margin lending was another factor in 2008.

      When you use bank credit to inflate asset prices, the debt rises much faster than GDP.

      The UK:

      Before 1980 – banks lending into the right places that result in GDP growth (business and industry, creating new products and services in the economy)

      After 1980 – banks lending into the wrong places that don’t result in GDP growth (real estate and financial speculation)

      The economy booms due to the money creation that occurs with bank loans, and new money floods into the economy.

      There is inflation.

      In asset prices, not consumer prices, so the central banks don’t notice.

      What’s wrong with neoclassical economics?

      1) The belief in the markets and price discovery gets everyone thinking you are creating real wealth by
      inflating asset prices.

      2) Bank credit pours into inflating asset prices rather than creating real wealth (as measured by GDP) and no one is looking at the debt building up.

      3) No one realises bank credit impoverishes the future.

      Understanding what Japanification is will help.

      Japan has been like this for thirty years and they have had a long time to study it.

      Austerity is the worst thing you can do.
      QE can’t enter the real economy due to a lack of borrowers.

      If you know what it is, you can come up with sensible policies.

      Japan has been paying back the debt from its 1980s excesses and this is the problem.

      Debt repayments to banks destroy money and have been pushing the Japanese economy towards debt deflation (a shrinking money supply).

      The money supply ≈ public debt + private debt

      As they have deleveraged the “private debt” component of the money supply has gone down.

      They have maintained the money supply with the “public debt” component and this is why Japanese government borrowing has ballooned.

      As they deleveraged a private debt problem, they created a public debt problem.

      If they hadn’t maintained the money supply they would have had a Great Depression type event, where debt deflation takes hold.

      Adair Turner has built on Japan’s experience to come up with a better solution.

      Government created money.

      You may not like it, but compare it to the alternatives.

      1. notabanktoadie

        Before 1980 – banks lending into the right places that result in GDP growth (business and industry, creating new products and services in the economy) Sound of the Suburbs

        So using what is, in essence*, the PUBLIC’S CREDIT but for private gain is justified if it results in new products and services?

        Who doesn’t like new products and services but if the finance is not ethical then what good are they if the public can’t afford to buy them?

        Likewise what good are productivity increases if they are not ethically financed so the workers displaced may at least have a share in equity or a share in profits to replace their lost wages?

        *Because of government privilege such as deposit guarantees, lender/asset buyer of last resort, positive interest and yields on risk-free sovereign debt, etc.

  8. Spencer Hall

    It is secular strangulation not stagnation. It’s just the idling of savings. It was predicted in the late 1950’s. You see, banks do not loan out deposits, banks create deposits when they lend/invest. So, $11 trillion in savings are frozen in the U.S. payment’s System. As Nobel Laureate Dr. Milton Friedman pontificated:

    “The only relevant test of the validity of a hypothesis is comparison of prediction with experience.”

    The 1966 Interest Rate Adjustment Act is prima facie evidence.
    The 1981 “time bomb” (widespread introduction of ATS, NOW, and MMDA accounts) is prima facie evidence.
    The 2012 expiration of the FDIC’s unlimited transactions’ deposit insurance is prima facie evidence (caused the “taper tantrum”).

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