The Case Against Secular Stagnation
In his excellent new blog, former Federal Reserve chairman Ben Bernanke argues against the view that the economy is caught in a trap of persistently slow growth -- "secular stagnation." He discusses a paper by James D. Hamilton, Ethan S. Harris, Jan Hatzius and Kenneth D. West, which anybody interested in the subject should read. It's the most careful analysis of the issue I've seen. And it suggests that fears of secular stagnation are overdone.
Secular stagnation is an old theory that Larry Summers has argued might fit the modern economy pretty well. The tepid pace of the current U.S. expansion lends the idea instant plausibility. However, with the economy still in the shadow of the worst recession since the 1930s, a delayed recovery isn't that surprising. More unsettling is the thought that secular stagnation might have set in earlier, during the 1990s or before, as Summers suggests.
Growth looked healthy for much of that time, but according to Summers this was because a series of bubbles and financial excesses boosted demand. Recall that secular stagnation is caused by a chronic excess of savings (hence shortfall of demand), one that monetary policy can't remedy if interest rates are already very low. Bubbles can provide the missing stimulus, but only briefly and at the cost of periodic financial turbulence.
Bubbles, according to Summers, disguised the entrenchment of a sluggish new normal for two or more decades before the crash. The implication is that if the Fed succeeds in avoiding bubbles from now on, growth will be sluggish even when the economy has shrugged off the after-effects of the crash.
The paper by Hamilton and his colleagues looks at this directly, asking whether secular stagnation plausibly began in the 1990s or even earlier. It's a technical study, but the section called "A narrative interpretation of historical real rates" is mostly accessible to the general reader. The conclusion is that the evidence for secular stagnation is weak -- "the timing of the alleged bubbles doesn't really fit the stagnation story."
The 1980s saw a boom in commercial real estate and a surge of easy lending from the savings-and-loan industry. The boom and the lending subsided in the middle of the decade and the stock market crashed in 1987 -- but unemployment stayed low regardless. That doesn't fit. In the 1990s, the timing was off in the other direction. There was a bubble in technology stocks, but this formed after the economy had already reached and possibly surpassed full employment. The bubble did help to cause a later excess of demand, but the economy didn't need it (contrary to the secular stagnation theory) to get to full employment in the first place.
The case of 2000 to 2008 is more complicated. There was a housing bubble, sure enough, fueled by reckless lending. This combination drove demand and raised employment -- yet not so much as to cause overheating and inflation. If not for the bubble, would the economy have been stuck with persistent unemployment, just as the secular stagnation theory suggests? Not necessarily, say the authors.
Through various channels, they estimate, the credit boom and housing bubble added about 1 percentage point of growth each year from 2002 to 2005. But this wasn't the only shock affecting the economy. Growth was slowed by rising oil prices and a growing trade deficit. Together, these subtracted nearly as much from the growth of demand as the bubble was adding. If none of these shocks had happened, the economy might still have reached and sustained full employment.
Since the crash, the economy has had to contend with a lot. Banks, businesses and households have all been repairing their balance sheets: Deleveraging has suppressed demand. In addition, fiscal policy has been tightened sharply since 2011, again subtracting demand. On top of this came recurring fiscal crises, with threatened defaults and government shutdowns, presumably subtracting still more. There's little reason to suppose that, if and when these braking forces are removed, getting the economy to full employment and keeping it there will require a bubble as well.
Hamilton and his co-authors sum it up this way:
In some ways the received wisdom on the economy has come full circle: The optimistic "Great Moderation" has been replaced with its near-opposite, "Secular Stagnation." The truth seems to be somewhere in between. Some of the moderation was earned at the expense of asset bubbles. Some of the stagnation is cyclical. If our narrative is correct, the weak economic recovery of the past five years is not evidence of secular stagnation, but is evidence of severe medium-term headwinds.
We'll know in another few years. But I'll be surprised if that judgment turns out to be wrong.
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