Secular stagnation & Keynes

"The ‘Keynesian’ solution to secular stagnation is not simply fiscal stimulus – it’s as much about dealing with the ‘financialisation’ of investment planning, combating short termism and taking inequality seriously."

Duncan Weldon
28 November 2013

The secular stagnation debate is producing some excellent blogging.

On Wednesday I argued that stagnation, bubbles & inequality were all linked – a point picked up by Rick at Flip Chart Fairy Tales, who writes that:

“In other words, the corporate executives of the early postwar world paid their workers high wages. This increased demand and fuelled growth but also meant that companies needed to invest. After the 1980s, executives began to take a much greater share of wealth out of their companies. They then lent it, through the burgeoning financial services industry, to their now much lower paid workers. The debt based consumption filled the gap left by the wage-based consumption of earlier years. Or, at least, it used to…


What started in the 1980s as an assertion of management’s right to manage and a repudiation of the collectivist corporatism of the 1970s has resulted in a wealth imbalance that may have disastrous and long-lasting economic consequences.”

This point is echoed by Matthew Klein at Bloomberg who notes:

“It seems more likely that the real problem is the dramatic concentration of wealth and incomes during the past 30 years. Those who have much more than they can ever hope to spend don’t increase their consumption by much when their incomes increase. Instead, they tend to save the extra dollars. Many others tried to compensate for their stagnant incomes by borrowing more and more. That enabled spending but created the danger of excess indebtedness.”

As an aside, Dan Davies has a slightly different story to tell focused on globalisation.

“My point here is that none of this was unknown at the time. The US economic policy structure was aware that they were accommodating China and NAFTA, and aware that the tool of demand management was consumer spending. They might or might not have been aware that the consumer spending was financed by borrowing against housing wealth, but if they weren’t, they thundering well should have been. They got a structural increase in personal sector debt because they wanted one and set policy in order to create one. There’s no good calling it a “bubble” or a “puzzle” now that the shit’s hit the fan.”

For what it’s worth, I don’t think Dan’s story is necessarily inconsistent with my own. Whether we call it a bubble or talk about ‘secular stagnation’ is in some ways a question of semantics. We can all recognise a declining investment share of GDP, rising reliance on household spending that itself was reliant on debt, rising inequality and rising in stability.

I put a bit more emphasis on changing corporate behaviour and weakened labour bargaining power , whilst for Dan the key is globalisation and rising propensity to import. In reality all these factors are at play.

The framework I tend to use for understanding the link between financial innovation, consumer debt and global imbalances it is that of Brender & Pisani as outlined in this 2009 Brad Setser post.

“Brender and Pisani demonstrate, the stability of the system that financed the US household deficit — and a slew of deficits in various European countries with housing booms — hinged both on the willingness of emerging market central banks to take exchange rate risk AND on the willingness of private intermediaries to take the credit and liquidity risk associated with lending at long-terms to ever more-indebted households. And the weak link in the system — as Nouriel realized before most — was the ability of private financial intermediaries to keep on taking credit and liquidity risk.”

Chris Dillow reminds us that this is not a new problem.

“The thing is, there is nothing much new in what Summers says. Ben Bernanke’s famous “investment dearth” speech was made eight years ago, and UK firms’ capital spending has been lagging behind retained profits for over a decade. The lack of investment which lies behind sluggish growth is an old problem.”

Whilst Simon Wren-Lewis looks at some of the more technical points around why the natural rate of interest may be negative and the implications of this.

As Simon writes:

“A major reason why high government debt is a problem in the medium to long term is that – unless Ricardian Equivalence holds – it crowds out private capital. It does that by raising the NRR. Too much saving goes into buying government debt, so there is not enough to invest in private capital. Yet if the NRR is actually negative, and likely to stay very low for some time, and this is a problem because of the ZLB, then the fact that government debt is currently raising the NRR is useful. To put it another way, this means we have plenty of time to deal with the problem of government debt.”

This echoes the points made by Paul Krugman and chimes quite nicely with Dan’s conclusion that:

“… the need for fiscal policy is such an obviously correct and obvious fact that more or less any economic argument is going to end up there unless it has major logical or accounting errors.”

But the question to me is actually a bit bigger – fiscal policy is obviously part of the solution to our current woes but is it enough?

As many have noted, who can understand most the current debate with a copy of the General Theory.

Paul Krugman has previously argued that there are two types of Keynesian.

“I’d divide Keynes readers into two types: Chapter 12ers and Book 1ers. Chapter 12 is, of course, the wonderful, brilliant chapter on long-term expectations, with its acute observations on investor psychology, its analogies to beauty contests, and more. Its essential message is that investment decisions must be made in the face of radical uncertainty to which there is no rational answer, and that the conventions men use to pretend that they know what they are doing are subject to occasional drastic revisions, giving rise to economic instability…


Part 1ers, by contrast, see Keynesian economics as being essentially about the refutation of Say’s Law – the possibility of a general shortfall in demand. And they generally find it easiest to think about demand failures in terms of quasi-equilibrium models in which some things, including wages and the state of long-term expectations in Keynes’s sense, are held fixed while others adjust toward a conditional equilibrium of sorts. They draw inspiration from Keynes’s exposition of the principle of effective demand in Chapter 3, which is, indeed, stated as a quasi-equilibrium concept: ‘The value of D at the point of the aggregate demand function, where it is intersected by the aggregate supply function, will be called the effective demand’.”

I’m tempted to go further and say there are three types of Keynesians – Part 1ers, Chapter 12ers and the majority – those who haven’t actually read the General Theory.

But I’m not at all sure that it is fair to divide up Keynes like this. Part 1, Chapter 12 and all the rest work well together. Part 1, as Krugman notes, provides a theory for thinking about our current problems in terms of effective demand but chapter 12 gives an excellent account of what would now be termed ‘financialisation’, which I think is one factor explaining our longer term problems.

Thus certain classes of investment are governed by the average expectation of those who deal on the Stock Exchange as revealed in the price of shares, rather than by the genuine expectations of the professional entrepreneur. How then are these highly significant daily, even hourly, revaluations of existing investments carried out in practice?

Left Outside quotes Skidelsky on his reading of Keynes:

“Hence, apart from keeping interest rates permanently low, investment needed to be ‘socialised’. Keynes wrote: ‘I expect to see the State…taking an ever greater responsibility for directly organising investment’ and ‘I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment’ (Keynes, 1973A, pp. 164, 378).


By ‘socialisation of investment’ Keynes did not mean nationalisation. Socialisation of investment need not exclude ‘all manner of compromise and devices by which public authority will co-operate with private initiative’ (Keynes, 1973A, p. 378). This single throw-away line in the General Theory reflects Keynes’s thinking on ‘public-private partnerships’, which came out of his involvement in Liberal politics in the 1920s (Skidelsky, 1992, chs 7 and 8). In essence, he sought to expand the public-utility component of investment to give greater stability to the investment function.”

All of which takes us rather beyond Part 1, Chapter 12 and firmly into the realms of chapter 24 on social philosophy.

“Thus our argument leads towards the conclusion that in contemporary conditions the growth of wealth, so far from being dependent on the abstinence of the rich, as is commonly supposed, is more likely to be impeded by it. One of the chief social justifications of great inequality of wealth is, therefore, removed. I am not saying that there are no other reasons, unaffected by our theory, capable of justifying some measure of inequality in some circumstances. But it does dispose of the most important of the reasons why hitherto we have thought it prudent to move carefully. This particularly affects our attitude towards death duties: for there are certain justifications for inequality of incomes which do not apply equally to inequality of inheritances.”

All of which matters. To see Keynesian as essentially the science of demand management whether through fiscal or monetary policy is to miss a great deal.

The ‘Keynesian’ solution to secular stagnation is not simply fiscal stimulus – it’s as much about dealing with the ‘financialisation’ of investment planning, combating short termism and taking inequality seriously.

Which is why I think the broader ‘economic reform’ agenda – taking in banking, corporate governance, industrial policy, wage setting and the rest – is a far more ‘Keynesian’ agenda than simply arguing for 2% of GDP to be spent on capital projects.

Dealing with our current problems will almost certainly require more government capital spending  - but that’s the start of the process, not the end.  An awful lot of the ‘economic’ solutions that we need sound more ‘political’ but then, as I wrote this summer, political economy usually trumps macroeconomics.


Crossposted with thanks from the Touchstone blog.

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