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NS4053 Winter Term 2015
Hansen and the Stagnationists
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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
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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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