NS4053 Winter Term 2015

Hansen and the Stagnationists

Hansen I

• Alvin Hansen – Harvard 19302, 40s and 50s

• First developed the theory of economic maturity or secular stagnation

• Controversial – application of basic Keynesian model to long-run growth.

• Keynes argued deficient demand could occur in the short-run.

• Hansen extended this idea into the long run

• Implication: Governments would have to:

• Fill an increasing gap between aggregate supply and demand

• Structure monetary and fiscal policy to maintain full employment

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Hanson II

• Hanson’s basic assumption:

• Tendency for private investment to fall and thus

• National income to drop and unemployment to increase

• In this situation governments can do three things:

• Increase public investment

• Can reduce taxes or

• Redistribute income from savers to spenders

• Complete policy for maintaining steady growth might involve a mixture of all three.

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Hanson III

• Factors that Hanson felt would drive the economy toward stagnation:

• Capital saving innovations increasingly common

• Heavy industries completed

• Great new industries argument

• Felt that major innovations and industries in place – future innovations less significant in their impact

• Loss of frontier spirit

• Less risk taking – investment in infrastructure

• Rising propensity to save

• With higher incomes less proportion of incomes needed for comfortable lives

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Hanson IV

• Again, a number of bad assumptions.

• No reason to believe any of the key assumptions will play out for extended periods of time

• Again, Hanson did most of his writing in the depression and immediate post-depression period when it was unclear whether or not economies would return to depression.

• Still there is the current fear that Europe and other parts of the world may be headed into a period of prolonged station or “lost decades” as Japan experienced

• If true, this would have great significance for the emerging economies

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Overview I

• Oxford Analytica, “Risk of Secular Stagnation is Rising,” March 7, 2014

• As pace of global recovery continues at a slow pace concern that developed economies may enter a period of “secular stagnation.Idea put forward by modern Keynesians, Larry Summers and Paul Krugman

• Relies on Keynesian intuition that demand is currently insufficient to

• Match idle capacity

• Boost economic growth, or

• Lower unemployment

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Overview II

• Stylized Facts

• More than five years after the global financial crisis,

• GDP growth across advanced economies is weak,

• Unemployment stubbornly high

• Inflation low, threatening to turn to deflation

• Rising income inequality and foreign reserve accumulation are

• Contributing to lower consumption and excess savings at global level

• Which has dampened the impact of historically low interest rates

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Overview III

• Main propositions of the stagnationists:

• Unless week demand is addressed, supply side reforms that increase capacity will not boost growth

• Increased capital requirements by banks will constrain credit, diminishing the impact lower borrowing costs have on investment

• Addressing income inequality through tax reform would help boost domestic demand

• The worry is that

• secular stagnation might result in a structurally lower economic growth potential,

• condemning advanced economies to years of growth to weak to reduce unemployment

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Causes of Secular Stagnation• Summers identifies the global savings glut – a chronic

shortage of investment relative to savings• Main cause of weak demand and slow growth• Income inequality

• Growing disparity between income earners at the top and bottom of the income distribution has an adverse impact on global demand

• The very rich consume proportionally less of their income than the middle class or poor

• This drives savings up and global demand down.

• Foreign reserve accumulation

• The built up of foreign reserves by countries relying on export led growth rather than domestic demand reduces consumption.

• This boosts savings and hurts global demand

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Solutions to Stagnation I• A number of broad policy solutions have been put forth

to counter secular stagnation:

• Real interest rates

• One solution to boost demand would be to further lower real interest rates (interest rates minus inflation)

• While interest rates have fallen in recent years, equilibrium interest rate (that is consistent with full employment) has fallen further

• Implies that in order to stimulate the economy by encouraging borrowing, real rates must fall far below the low – and in some cases negative – rates currently seen

• Lowering real rates could be achieved by central banks using unconventional monetary policy such as quantitative easing (QE)

• Another solution: lower real rates by increasing inflation expectations (anticipated inflation) 10

Solutions to Stagnation II

• Fiscal Policy

• Public stimulus measures – similar to those seen in the recession could be effective in ending secular stagnation

• Public authorities could breathe life into sluggish economies by increasing investment directly

• Summers preferred method for addressing securer stagnation

• Not only does public infrastructure investment not require an institutional change, makes sound economic sense given that many governments face negative real rates with borrowing in financial markets.

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Solutions to Stagnation III

• Structural reforms

• Advocated by the OECD in 2014 Report “Going for Growth.

• Recommended measures include

• Lower product market regulation

• Enhancing competition

• Reforming pubic education systems and further liberalization of labor markets

• Such measures would be effective in boosting capacity and raising growth potential in the long run.

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Limitations to Solutions I

There are serious limitations to the policy responses offered by the Keynesians to counter secular stagnation:•Zero-lower bound

• Central banks lose the ability to stimulate the economy when interest rates are at or near zero.

• Even quantitate easing (QE) measures in this environment have not been sufficient to boost growth

• Philosophy is to get investors to move into riskier assets – same problem that caused the 2008 collapse in the first place

•Bubbles

• Extremely low interest rates and QE might actually become counter productive

• Have caused prices of assets to increase rapidly

• May create bubbles in housing and assets triggering financial stability

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Limitations to Solutions II• Public Finances

• In much of developed world there is very little room for maneuver when public debt is close to or higher than 100% GDP

• Currently the case in the U.S. United Kingdom and France

• Political Consequences

• Unlike monetary policy fiscal policy solutions require democratic debate and political conseqnces

• Might be emerging consensus on fiscal policy at the global level (IMF, G20), but clearly lacking in the US and EU

• EU rules government public deficits and debt prevent any fiscal stimulus from being implemented

• Political gridlock between Democrats and Republicans has prevented any public investment strategies since the passing of the 2009 stimulus bill

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Limitations to Solutions III

• Timing

• Investment in innovation and knowledge that raises the growth potential of the economy is always beneficial, but will do little to foster demand in the short tun

• Of these limitations the lack of political will and consensus is the most serious as infrastructure investment would likely be the most timely and effective way of addressing secular stagnation

• Institutional deadlocks prevent this.

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Conclusions

Summing up•Policy solutions to address secular stagnation – and slow growth more generally – appear few and far between•The United States and EU are very unlikely to engage in the kind of strategies – particularly pubic investment that might reduce secular stagnation risk

• U.S. political system is polarized

• Tax policies to smooth out income distribution and raise purchasing power of lower income groups a non-starter

• Increased minimum wage a very inefficient way to do this

• EU is constrained by strict fiscal policy rules

•Without political consensus advanced economies could risk entering a period of prolonged structurally soft growth.

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