Beyond Secular Stagnation
by Joseph Stiglitz – September 5, 2018
There is no reason economists should agree about what is politically possible. What they can and should agree about is what would have happened if their preferred policies had been implemented – and keep those lessons in mind as the next downturn approaches.
NEW YORK – As Larry Summers rightly points out, the term “secular stagnation” became popular as World War II was drawing to a close. Alvin Hansen (and many others) worried that, without the stimulation provided by the war, the economy would return to recession or depression. There was, it seemed, a fundamental malady.
But it didn’t happen. How did Hansen and others get it so wrong? Like some modern-day secular stagnation advocates, there were deep flaws in the underlying micro- and macroeconomic analysis – most importantly, in the analysis of the causes of the Great Depression itself.
As Bruce Greenwald and I (with our co-authors) have argued, high growth in agricultural productivity (combined with high global production) drove down crop prices – in some cases by 75% – in the first three years of the Depression alone. Incomes in the country’s major economic sector plummeted by around half. The crisis in agriculture led to a decrease in demand for urban goods and thus to an economy-wide downturn.
WWII, however, provided more than just a fiscal stimulus; it brought about a structural transformation, as the war effort moved large numbers of people from rural areas to urban centers and retrained them with the skills needed for a manufacturing economy, a process which continued with the GI bill. Moreover, the way the war was funded left households with strong balance sheets and pent-up demand once peace returned.
An analogous structural transformation, this time not from agriculture to manufacturing, but from manufacturing-led growth to services-led growth, compounded by the need to adjust to globalization, marked the economy in the years before the 2008 crisis. But this time, mismanagement of the financial sector had loaded huge debts onto households. This time, unlike the end of the WWII, there was cause for worry.
As Summers well knows, I published a widely cited commentary in The New York Times on November 29, 2008, entitled “A $1 Trillion Answer.” In it, I called for a much stronger stimulus package than the one President Barack Obama eventually proposed. And that was in November.
By January and February 2009, it was clear that the downturn was greater and a larger stimulus was needed. In that Times commentary, and later more extensively in my book Freefall, I pointed out that the size of the stimulus that was needed would depend both on its design and economic conditions. If the banks couldn’t be induced to restore lending, or if states cut back their own spending, more would be required.
Indeed, I publicly advocated linking stimulus spending to such contingencies – creating an automatic stabilizer. As it turned out, the banks weren’t forced to expand lending to small and medium-size businesses; they cut it drastically. States, too, slashed spending. Obviously, an even larger stimulus in dollar terms would be needed if it was poorly designed, with large parts frittered away in less cost-effective tax cuts, which is what happened.
It should be clear, though, that there is nothing natural or inevitable about secular stagnation in the level of aggregate demand at zero interest rates. In 2008, demand was also depressed by the huge increases in inequality that had occurred over the preceding quarter-century. Mismanaged globalization and financialization, as well as tax cuts for the rich – including the cut in capital-gains tax (overwhelmingly benefiting those at the very top) during the Clinton and Bush administrations – were major causes of accelerating concentration of income and wealth.
Inadequate financial regulation left Americans vulnerable to predatory banking behavior and saddled with enormous debts. There were thus other ways of increasing aggregate demand besides fiscal stimulus: doing more to induce lending, to help homeowners, to restructure mortgage debt, and to redress existing inequalities.
Policies are always conceived and enacted under uncertainty. But some things are more predictable than others. As Summers again knows full well, when Peter Orszag, the head of the Office of Management and Budget at the beginning of Obama’s first administration, and I analyzed the risks of mortgage lender Fannie Mae in 2002, we said that its lending practices at that time were safe. We did not say that no matter what it did, there was no risk.
And what Fannie Mae did later in the decade mattered very much. It changed its lending practices to resemble more closely those of the private sector, with predictable consequences. (Even then, notwithstanding the right-wing canard blaming Fannie Mae and the other government-sponsored lender, Freddie Mac, it was private-sector lending, especially by the big banks, that underlay the financial crisis.)
But what was predictable and predicted was the manner in which under-regulated derivatives could inflame the crisis. The Financial Crisis Inquiry Commission put the blame squarely on the derivatives market as one of the three central factors driving the events of late 2008 and 2009. Earlier in President Bill Clinton’s administration, we had discussed the dangers of these fast-multiplying and risky financial products. They should have been reined in, but the Commodity Futures Modernization Act of 2000 prevented the regulation of derivatives.
There is no reason economists should agree about what is politically possible. What they can and should agree about is what would have happened if…
Here are the essentials: We would have had a stronger recovery if we had had a bigger and better-designed stimulus. We would have had stronger aggregate demand if we had done more to address inequality, and if we had not pursued policies that increased it. And we would have had a more stable financial sector if we had regulated it better.
These are the lessons that we should keep in mind as we prepare for the next economic downturn.
Originally published on Project Syndicate.