Secular stagnation: Causes and consequences
Six years ago, on the verge of what would be known as the Great Recession, a fierce dispute erupted among pundits about the nature of the unfolding economic slump. The main sticking point of this “alphabet soup” debate was the shape the recession would take: V, U, L or W? Depending on the chosen letter, the political recommendations were quite different.
This debate petered out when other issues - US monetary policy, the euro crisis and slowing Chinese growth - took center stage. Yet in the last couple of months it has been revived in new form and taken to a whole new level. This time it is not cable news talking heads doing the arguing but a prominent panel, a Who’s Who, of mainstream academic macroeconomists.
The question is no longer about the shape of a recession, since the main Western industrialized nations (with the noticeable exception of Italy, which seems to be experiencing a triple U (or UW) recession, something no one dared predict back in 2008) are more or less growing again. The debate has shifted to what is now called “secular stagnation,” an expression coined by former US Treasury Secretary Larry Summers.
All economists involved in it acknowledge that the growth environment since the financial crisis differs from what it was before. If we look at the trend growth of a given industrialized country before the financial crisis, extrapolate it by calculating what the country’s GDP should be today had the Great Recession not occurred, and compare it to what it actually is, we notice a substantial gap. Take the US: its actual GDP is now 20% below what a linear trend extrapolation would have suggested in 2008.
Three theories are currently competing to explain this gap. The first one posits that economies should be able to claw their way back to the growth path they experienced before the financial crisis. The second claims that economies should return to the original pre-financial crisis trend growth rate, albeit at a lower parallel track to the original one. The third one, the most pessimistic, argues that the trend growth rate was permanently damaged by the financial crisis: economies will not only never return to their original path but will diverge more and more from it.
Here, even more than in the “alphabet soup” debate, the economic policy implications of each position vastly differ. Many economists who call themselves Keynesians assert that the only real difference between the Great Recession and a normal recession was its size. Hence, to return an economy to its old trend, policymakers simply need to apply anti-cyclical forces an order of magnitude greater than the ones already in place. In plain English it means they advocate for larger fiscal deficits and for printing even more money.
Coping with the second case is trickier. Any attempt to boost GDP above its new trend path by monetary or fiscal means will, at some stage, reignite inflation. So subtler tools need to be applied not to the gap itself but to what caused it in the first place, this camp argues. In the US, there is currently intense discussion about the “slack” in the economy and the drop in the labor market participation rate. Creating incentives for those who left the labor market to return to it, thereby increasing the participation rate, would boost the economy and restore it to its original growth path, proponents of this view contend.
The last and worst case of the three can be subdivided into a version that admits of hope and one that is fatalistic. In the hopeful version, while the financial crisis may have permanently damaged an economy’s trend growth rate, structural changes can be made to repair it. Similar arguments are offered for the recent experience of Germany, whose growth, some economists say, was structurally boosted by the implementation of Chancellor Gerhard Schroeder’s “Agenda 2010” back in 2005.
In the fatalistic scenario, defended by Northwestern economist Robert J. Gordon, we will never revert to the growth rates we enjoyed 10, 20 or 50 years ago because the pace of technological change has markedly slowed and there’s nothing we can do about it.
To avoid political mistakes it is paramount that economists solve the debate about the growth gap. The fact that it was defined in the first place is already a step in the right direction.