Stagnation: For Whom?

I read with interest Steve Keen’s latest tilt at Paul Krugman in the new edition of Real-World Economics Review. This has been an ongoing discussion, but we need not concern ourselves too much with it here.

Keen’s general point is that the money created when banks lend has to be taken into account within any model we use for explaining, tracking, and predicting economic growth. This is referred to as an endogenous money view. In contrast, Krugman, like most more orthodox economists, looks at money as being neutral in that it has no impact on the real economy and thus the amount of lending cannot have a major effect. Indeed Krugman is fond of pointing out that one person’s debt is another person’s credit and so the two sides of the ledger net out to zero. The importance of this  is that if money is indeed neutral then we not worry about the level of debt nor its rate of change when we seek to explain economic performance. This is referred to, generally, as the loanable funds view.

I am generalizing of course, but this is the heart of the debate.

Now: how do we explain what appears to be our current stagnation?

Krugman seems to contradict himself. He has argued, as Keen points out, that a major cause of our current malaise is that the private sector – households and businesses combined – have been shedding some of the enormous debt it accumulated during the prior thirty years or so. This suggests that debt does indeed have an impact on the economy. Krugman’s way of squaring this apparent contradiction is to argue that debt only matters in extreme conditions and particularly when the economy is in a liquidity trap with interest rates near zero and the interest rate needed to induce savers to spend and to slow the rate of debt reduction is actually negative. Since rates cannot be negative the economy suffers a kind of short circuit under such conditions and gets trapped in a self-sustaining downward cycle. Hence the name liquidity trap.  In other, more normal conditions, when rates are healthily positive, Krugman abandons the notion that debt matters and reverts back to orthodoxy.

This becomes important when we consider other underlying causes of stagnation.

Larry Summers has recently popularized the notion that our economy is stuck in something called secular stagnation. By secular he means that the slowdown is not caused by some temporary aberration that will go away and allow us to resume ‘normality’. He means that we have shifted into a new and less attractive new normality. In other words we ought to be prepared for longer term slow growth.

Set aside that this year we will see GDP pick up somewhat from 2013. That uptick will largely be caused by the ending of the negative impact of reduced government spending. It’s a good feeling to stop banging your head against a wall. So too, in 2014, we will feel better because we will stop the aggressive budget slashing of the last two years. Or, at least that what it looks like.

Looking at the longer term picture it is unquestionable that our economy has steadily slowed down. Whereas in the first two or three decades after World War II growth of 4.0%+ was not unusual, we now treat 3.0% with excitement and almost awe.

One possible cause of that slowdown is simply that our population is growing more slowly. The steady influx of new workers and consumers into the system provided a significant boost in those earlier years, and since population growth has slowed that boost, too, has slowed.

A deeper argument is that made popular recently by Robert Gordon who argued that a major factor is simply that our new technologies are nowhere near as important as those of previous generations. Thus the advent of electricity had, according to Gordon, a much more significant impact on growth potential, than the Internet has had or will have. This argument suggests that the growth effect of current innovation is too low to get us back to those 4.0%+ growth days, and that we ought to throttle back on our expectations for the future.

This has wide-ranging importance.

It suggests that we have to re-think how we pay for social programs, or whether we can sustain them at current levels. It suggests we need to pay more attention to the supply side of the economy and find ways to encourage innovation – perhaps by cutting corporate taxes. And it suggests that we need to reduce the alleged overhang of government debt since future growth will be insufficient to bring the debt ratio down effectively and may not even be sufficient to provide for interest payments without drastic retrenchment of spending.

In other words, the stagnation discussion now underway could have profound consequences for many of the ways in which we conduct our national business.

Which is why I want to go back to the debt and aggregate demand question.

I think there is a narrative that squares the circle.

The private sector went into debt, and thus masked the onset of stagnation, by boosting demand – which is what Keen asserts and which Krugman has a hard time coming to terms with – not because innovation was slowing the engine of growth and restricting income growth, but because the rewards from innovation were being distributed ever more asymmetrically.

It was rising inequality, not a lack of spectacular innovation, that caused the onset of stagnation. We crippled the consumer engine by starving it of its share of the rewards – wages fell steadily as a share of the economy and thus deprived consumers of spending power. We cannot critique the impact of the Internet without recognizing that a majority of the productivity gains produced by recent innovations have gone to an ever shrinking segment of the population. Because the wealthy minority tend to spend a smaller proportion of their incomes, overall spending slowed. Conversely, because the wealthy also save more of their income, the economy was increasingly flooded with cash in search of higher rates of return than those offered by an economy teetering on the borders of stagnation. this increasing ‘financialization’ of the economy had an enormously de-stablizing impact and drove us into the Great Recession.

So debt matters. So does its distribution. And so does the root cause people borrow.

This explains why average households borrowed more – the lack of wage growth forced people into debt in order to keep up the appearance of a rising standard of living. It explains why the financial sector became more volatile – it was the epicenter of that search for higher returns. It explains why recent innovation appears to have been less effective – the rewards weren’t widely distributed with the knock-on effect of slowing consumer demand absent debt. And it helps expose why the low interest rate and low inflation era which was dominated, from a policy point of view, by an obsession on policies that privileged wealth, business, and creditors has produced what Summers calls secular stagnation.

We don’t have a secular stagnation if you’re one of the creditors and rentiers who derive their income from capital or who manage to scarf up a disproportionate part of the rewards from innovation.

No.

We don’t have a secular stagnation. We have a failure – over about thirty to forty years – of policy. This was self-inflicted. We need to un-inflict it.