Sunday, September 2, 2018

Secular Stagnation, Myth and Reality

I ran into an article by the usually excellent Joseph Stiglitz on secular stagnation, entitled "The Myth of Secular Stagnation," see here. The gist of the article appears to be that the idea of secular stagnation is some sort of a ploy to absolve policy makers from responsibility of the slow recovery from the Great Recession. I think this view is so fundamentally wrongheaded that it seems worthwhile waking this little blog up from the dead to offer a brief comment on this notion.

I suppose I should disclose some relevant biases before going further. When Larry Summers first mused about the secular stagnation idea in a speech at the IMF in the fall of 2013, Neil Mehrotra and I wrote a little paper a couple of months later, see here, which as far as I know was the first attempt to formalize it in a modern DSGE model. Later, with the help of our graduate student Jake Robbins, we moved beyond a simple theoretical illustration to explore a quantitative version of the hypothesis, see here, in a paper that is coming out in American Economic Journal: Macroeconomics. In the meantime, I have written a series of paper with said Larry Summers, and various co-authors, that have explored several aspects of this idea, see here, here and here. Admittedly, it comes as a surprise, if I had unwittingly been participating in some enterprise that supposedly absolved policymakers of any responsibility for the slow recovery!

The biggest, and perhaps most obvious, problem with Stiglitz argument, is the following: If the secular stagnation hypothesis is correct, this does not in any way absolve policy makers from responsibility for a slow recovery. Instead, it does exactly the opposite. If correct, the secular stagation hypothesis implies that policymakers should have done much more in 2008 than existing theories suggest.

What is the secular stagnation idea anyway? In prior work, the way most people, myself included, had thought about the crisis of 2008 when the US and most of the rest of the world hit the zero lower bound, was that it was due to some temporary forces, such as being generated by a debt deleveraging cycle (see e.g. my work with Paul Krugman here) or being driven by problems in the banking sector (see e.g. joint work with Del Negro, Ferrero and Kiyotaki, see here). But in any case, most of these theories where ones in which the forces leading to ZLB were temporary, and thus one strategy for policy (for example if the cost of policy intervention was considered very high) was one of just waiting it out, as "soon all would be well" using Stiglitz words.

What separated Larry's secular stagnation hypothesis from much of the earlier work was that he suggested that the forces that might be driving the fall in the natural rate of interest, triggering the ZLB, might not be temporary after all but instead ones that would not necessarily revert themselves. The literature has identified several plausible candidates, such as demographic change, fall in productivity, global savings glut, rise in inequality and so on, essentially any force that might trigger the relative supply of savings and investment to be such that the natural rate of interest is permanently (or very persistently) negative. What was sort of interesting about modeling the secular stagnation hypothesis was that one needed to do both an open heart surgery on the aggregate demand side of traditional DSGE models (to allow for permanently negative interest rates) and also do a radical change on the supply side to allow for the possibility of a permanent demand recession (a big no-no in traditional macro which typically assumes long run neautrality). In any case, the bottom-line of this research, contrary to what Stiglitz appears to think, is that the secular stagnation hypothesis gives an even stronger case for aggressive intervention, e.g. in 2008. Thus far from being "just an excuse for flawed policies" the hypothesis gives a compelling reason to believe that more should have been done in 2008.

It is hard to end this little note, without responding briefly to Stiglitz's notion that events of last year have "put a lie to this idea" but Stiglitz suggests that the the fiscal expansion under Trump is responsible for some of the current recovery (a suggestion I will take for granted for the purpose of this argument, but one that could be contested). It is odd to suggest that current events put a "lie to the idea" of secular stagnation, for a recovery based on fiscal expansion is precisely the prediction of the secular stagnation theory: With low interest rates there is more room than usual for a fiscal stimulus, i.e. it is less likely to call for rapid offsetting increase in interest rates by the Federal Reserve than usual due to the absence of inflationary pressures created by the fiscal expansion (which so far, seems pretty much on the mark, as inflation remains subdued in spite of the large fiscal expansion). So here, Stiglitz, seems to get things exactly upside-down. At the end of the day, I suspect that the implication of a secular stagnation diagnostic of 2008 is -- after all -- very much in line with the view Stiglitz expresses here and often elsewhere, that the "fallout from the financial crisis was more severe, and massive redistribution of income and wealth toward the top had weakened aggregate demand" and that "the downturn was likely to be deep and long" and that what was needed was "stronger and different from what Obama proposed". Indeed, the secular stagnation hypothesis puts structure on those very arguments which I am quite sympathetic to. 

Finally a little figure and some reflections on the future. The figure above shows the cut in the Feds Fund rate in response to past three recessions as identified by NBER (in gray bars in the figure). In the early 1990's the Fed had room to cut rates from 10 to 3 (700 basis points), in early 2000 from 6.5 to 1 (550 basis points) and in 2008 from 5.25 to 0 (525 basis points). The secular stagnation hypothesis entertains the possibility that the observed fall in real interest rate (evident in the figure by the downward trend in long-term rates shown in red) over the past decades is "secular" which implies that come next recession, the Fed may have much less room to cut rates than it has had before, smaller than on the last 3 occasions. As much as I would like to hope that this will turn out NOT to be the case, it seems to me to be exceedingly likely the Fed may run out of room yet again when the next shoe drops, especially if the current recovery ends in tears in the next year or two as many now appear to be suggesting. With somewhat limited options to do monetary expansion at that point, this suggests we should be thinking hard about what fiscal policy can do the next time around. I suspect Stiglitz would agree on this point with those of us that have been entertaining the secular stagnation hypothesis. 


  1. Great post. Now reexamine the arguments made therein in lieu of (1) no money illusion, (2) wage and price non-stickiness. If the argument still stands, it's a winner. Otherwise...

  2. As far as I can tell from having looked over a few of the papers referenced above, they all fail to acknowledge a fundamental truth of bank credit cycles - that credit booms are fueled by banks creating purchasing power from thin air, while busts are explained in large part by that bank money creation process reversing in a deleveraging.

    I would say the "open heart surgery" that's required is to stop specifying models built on the erroneous assumption that money is exogenous.

  3. The idea that "secular stagnation" called for a larger (though differently directed) stimulus is fine as far as it goes, but is limited by the apparent belief that the Fed could not have provided more monetary stimulus. Even if the interest rate on ST government bonds is zero there is still plenty of other things that the Fed can buy: Long tern US securities, private securities, foreign exchange. to persuade the market that it means business in carrying out its mandate to keep the price level growing as a fairly steady rate and employment as close to full as possible. Unfortunately, the Fed was NOT trying to keep the price level growing but rather had an inflation rate ceiling.

  4. I very much like using the OLG framework to address this issue. Although I didn't call it "secular stagnation" in this piece, something similar happens with a "negative news shock" on investment return; see here:

    Also, real interest rate can go negative in OLG model owing to increase in foreign demand for U.S. Treasury debt; see here:

    Hope to see more researchers making use of this framework!

  5. Are you claiming Larry S advised Obama
    In fall 2008
    Assuming recovery would be reasonably
    And then
    A bit too late realized
    missed the underlying macro stagnation

  6. If so

    THE alibi line is off
    But the criticism
    retains its sting





  7. Seems inconceivable that Stiglitz is unable to understand secular stagnation, which is not that hard even for non-economists. More likely it's personal. Recall how Stiglitz went on a crusade for Janet Yellen while lambasting Summers as being unfit for the job of Fed chairman.

    In retrospect, if Summers had been appointed rather than Yellen there would likely have been far fewer rate hikes and far more dovish forward guidance on rates that would have forestalled the rise in the dollar in 2016 that undoubtedly helped Trump win a very close election by crimping farmers' export prices.

    1. .
      I agree that it appears there is something going on behind the scenes.

      Stiglitz is way too smart.

      But I disagree with the belief that Summers would have been some kind of White Knight at the Fed.

      As Treasury secretary under Bill Clinton, Summers was instrumental in undoing the main provisions of the Glass-Steagall Act. Nine short years after the repeal of that act America had its worst financial crisis since the Depression.

      Summers has also been an outspoken critic of regulating the derivatives market, which is estimated to be worth over $700 trillion (10x GWP).

      By deed and by word, Summers showed that he was not fit to run the Federal Reserve.

    2. You seemed to have missed my point. Secular stagnationists recogized long before the Yellen Fed that the natural rate had fallen and therefore that there was no hurry to "normalize" interest rates. Yellen did finally recognize the natural rate had indeed fallen (and Summers gave her credit) but it was too little too late. If Yellen were a secular stagnationist going in she would have pushed for a more dovish monetary policy from the FOMC members.

      So, secular stagnation has as much to say about monetary policy as fiscal policy.

  8. Not a word about the spike in oil prices. Oil had been rising steadily since the end of Clinton administration. Then it reached $3, $4, $4.50. The cause of the great recession was the failure of our government to understand how growth drives inflation.

  9. Secular strangulation is chronically deficient AD. AD decelerates because savings become impounded (as DFI-held savings are un-used and un-spent). This is inviolate and sacrosanct. DFIs pay for their new earnings assets with new money, not existing deposits. This began in 1981 - exactly as predicted in 1961. It was exacerbated by remunerating IBDDs. The expiration of the FDIC’s unlimited transaction deposit insurance in Dec. 2013 (causing the taper tantrum), partially and temporarily reversed this stoppage in the flow of funds. The transactions velocity of circulation accelerated as the proportion of time deposits to transaction type deposits reversed in mid-2016.

  10. This was documented in 1961 in “Should Commercial banks accept savings deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43.

    The fact Is: people are lemmings. Mr. MaGoo was already “hard wired”. As Dr. George Selgin told me:

    “None of this would matter if the Fed acted as an efficient savings-investment intermediary, as commercial banks are able to do, at least in principle.”

    “This is nonsense, Spencer. It amounts to saying that there is no such things as 'financial intermediation,' for what you claim never happens is precisely what that expression refers to."

    Princeton Professor Dr. Lester V. Chandler, Ph.D., Economics Yale, theoretical explanation was:

    “that monetary policy has as an objective a certain level of spending for gDp, and that a growth in time (savings) deposits involves a decrease in the demand for money balances, and that this shift will be reflected in an offsetting increase in the velocity of demand deposits, DDs.”

    His conjecture was correct up until 1981 – up until the saturation of financial innovation for commercial bank deposit accounts I.e., the saturation of DD Vt according to Dr. Marshall D. Ketchum, Ph.D. Chicago, Economics

    "It seems to be quite obvious that over time the “demand for money” cannot continue to shift to the left as people buildup their savings deposits; if it did, the time would come when there would be no demand for money at all”

    Thus, as Dr. Leland J. Pritchard, Ph.D. Chicago - Economics, M.S Statistics, Syracuse predicted after the passage of (1) the DIDMCA of March 31st 1980, i.e., coinciding with his prediction of the (2) "time bomb", the widespread introduction of ATS, NOW, & MMDA accounts, that money velocity had reached a permanently high plateau.

    Professor emeritus Pritchard never minced his words, and in May 1980 pontificated that:

    “The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”.

    Take note. DFIs do not loan out existing deposits saved or otherwise. All bank-held savings are un-used and un-spent. They are lost to both consumption and investment. This is the sole cause of Harvard Professor Dr. Alvin H. Hansen’s, Ph.D., Economics, Brown University, secular stagnation.

    As Dr. Pritchard’s economic syllogism posits:

    #1) “Savings require prompt utilization if the circuit flow of funds is to be maintained and deflationary effects avoided”…
    #2) ”The growth of commercial bank-held time “savings” deposits shrinks aggregate demand and therefore produces adverse effects on gDp”…
    #3) ”The stoppage in the flow of funds, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods.” Circa 1959

    Nobel Laureate Dr. Milton Friedman was one-dimensionally confused: From Carol A. Ledenham’s Hoover Institution archives: Friedman pontificated that: “I would (a) eliminate all restrictions on interest payments on deposits, (b) make reserve requirements the same for time and demand deposits”. Dec. 16, 1959. I.e., the iconic Friedman conflated stock with flow (not knowing as well, a debit, from a credit, i.e., flow).

    - Michel de Nostredame

  11. Take the “Marshmallow Test”: (1) banks create new money (macro-economics), and incongruously (2) banks loan out the savings that are placed with them (micro-economics).

    See Steve Keen: "Banks don’t “intermediate loans”, they “originate loans”.

  12. Percentage of time (savings-investment type deposits) to transaction type deposits:
    1939 ,,,,, 0.42
    1949 ,,,,, 0.43
    1959 ,,,,, 1.30
    1969 ,,,,, 2.31
    1979 ,,,,, 3.83
    1989 ,,,,, 3.84
    1999 ,,,,, 5.21
    2009 ,,,,, 8.92
    2018 ,,,,, 4.87 (declining mid-2016 with the increase in Vt)

  13. Historical FDIC’s insurance coverage deposit account limits (commercial banks):
    • 1934 – $2,500
    • 1935 – $5,000
    • 1950 – $10,000
    • 1966 – $15,000
    • 1969 – $20,000
    • 1974 – $40,000
    • 1980 – $100,000
    • 2008 – $unlimited
    • 2013 – $250,000 (caused taper tantrum)

  14. It’s stock vs. flow.
    Frozen savings ,,,,, Reg Q ceiling %

    11/01/1933 ,,,,, 0.0300
    02/01/1935 ,,,,, 0.0250
    01/01/1957 ,,,,, 0.0300
    01/01/1962 ,,,,, 0.0350
    07/17/1963 ,,,,, 0.0400
    11/24/1964 ,,,,, 0.0450
    12/06/1965 ,,,,, 0.0550
    07/20/1966 ,,,,, 0.0500
    04/19/1968 ,,,,, 0.0625
    07/21/1970 ,,,,, 0.0750

  15. Interest is the price of loan-funds. The price of money is the reciprocal of the price-level. Real interest rates fall when savings become impounded (it causes an excess of savings over investment outlets).

    To achieve higher and firmer real rates of interest for saver-holders outside the banks, you gradually drive the commercial banks, DFIs, out of the savings business.

  16. The NBFIs are not in competition with the DFIs. The NBFIs are the DFIs customers. Savings flowing through the NBFIs never leaves the payment's system as anyone who has applied double-entry bookkeeping on a national scale should already know.