Lawrence Summers recently placed the notion of secular stagnation back on the agenda. There is, he argued, a strong possibility that the Wicksellian natural rate of interest is negative and that, at any non-negative interest rate, saving will exceed investment leading to stagnation (see Summers 2014a, 2014b, and Teulings and Baldwin 2014). Whilst some policymakers, notably Ben Benanke, have dismissed the idea, others such as Christine Lagarde and Janet Yellen have taken it seriously. But how did it fare in history?
Secular stagnation: History of the concept
When secular stagnation is mentioned, the term is usually correctly attributed to Alvin Hansen’s 1938 AEA Presidential Address (1939). It is then commonly assumed that the three decades of low unemployment after WWII showed the doctrine to be clearly wrong. In contrast, we have recently argued that this considerably oversimplifies what happened (Backhouse and Boianovsky 2015).
Hansen presented secular stagnation as a historical thesis concerning the US economy when the 1937-8 recession – which happened before full capacity had been reached – raised questions about the long-term prospects for the US economy.
In contrast to those who explained the aborted recovery in terms of the combination of a business cycle with a 50-year Kondratiev cycle, Hansen suggested that stagnation might have long-term structural causes:
- The frontier had closed;
- The rate of population growth had declined; and
- The changing nature of technical progress meant that investment demand had fallen below what was needed to absorb savings.
All this created a tendency towards long-term stagnation. These were problems believed to be associated with economic maturity.
Politically loaded analysis
This was a politically contentious issue at the time. The implication of Hansen’s idea was that government deficits and hence a continually rising government debt might be necessary to ensure prosperity. This was unacceptable even to conservatives who could countenance temporary deficits to mitigate the business cycle.
Throughout the 1940s, there was active debate, dominated by economists associated with Hansen: Alan Sweezy, Benjamin Higgins, and Evsey Domar. Most important was Domar (1944) who tackled the problem of whether rising government debt was sustainable, analysing it in terms of what has come to be called the Harrod-Domar growth model.
Though Higgins was the one who did most to tie down the theoretical content of secular stagnation, crucial innovations came from Lawrence Klein (1947) and Don Patinkin (1948). Klein linked secular stagnation, for the first time, to the idea of a negative natural rate of interest, and Patinkin, developing an idea of Pigou, advanced the notion of the real balance effect. The real balance effect provided a theoretical argument against the idea that there could be a permanent shortage of aggregate demand. These developments involved a change in the way economists thought about the problem. Hansen approached macroeconomics as an institutionalist, rooted in the idea that markets were not necessarily competitive, and that many prices were likely to be set oligopolistically by large corporations. In contrast, by the time of Patinkin, arguments about stagnation were taking place in the framework of competitive general equilibrium theory. At the same time, the idea began to be associated with Keynes, rather than specifically with Hansen.
There was also a very important change in the way in which secular stagnation was conceived, best illustrated in successive editions of Economics, the textbook by one of Hansen’s students (Paul Samuelson) that dominated introductory economics teaching after its publication in 1948.
The first three editions provided a detailed discussion of Hansen’s thesis and the arguments against it. However, in the fourth edition (1958) this was shortened and 'secular stagnation' was contrasted against 'secular exhilaration'. The term had changed from being a historical thesis to being an analytical possibility. An economy might have a tendency to too little or too much aggregate demand. In the 1960s stagnation loomed larger, for unemployment at cyclical peaks had got progressively worse – 2.5% in 1952, 4% in 1957, and 5% in 1960. Secular stagnation – in the sense of an economy where, for whatever reason, government deficits were needed to sustain full employment – provided the justification for the Kennedy tax cuts and a higher government debt (the expansion later derailed when Johnson ignored the advice of his Keynesian economic advisers about the inflationary consequences of spending on the Vietnam War).
Like many prominent economists of his generation, Samuelson presumed an economy characterized by oligopoly and imperfect competition, and that costs were set by mark-up pricing under conditions of constant cost up to full capacity. In this theoretical framework there was no conceptual barrier to believing that the need for government spending to maintain full employment was an open question that needed to be tackled empirically. What changed this was the increased acceptance of perfect competition modelling, whether involving disequilibrium or continuous market clearing, which made it harder to escape the theoretical implications of the real balance effect and its implication that there must be full employment equilibrium in the long run.
Hansen’s thesis was about a 'mature economy' but in the post-war era, with increasing consciousness of what were then called 'under-developed' countries, there was much talk of 'modernisation'. The US was assumed to be technologically the most advanced economy, with which other countries were catching up. Its growth rate might be lower than growth in other countries, in that 'catching up' was not a source of growth available to it, but this did not imply stagnation. In Walt Rostow’s stages of economic growth, the US had reached 'the age of high mass consumption'. Seeing secular stagnation as a feature of a mature economy did not make sense in the way it had done in the 1930s.
The concept of secular stagnation evolved and never completely disappeared from view but it went out of fashion for a combination of reasons. The US prospered after WWII, though there was room for debate over whether this was only because the government spending to maintain demand was taking place. This was the view of the Keynesians advising Kennedy and Johnson in the sixties. Stagnation came to be associated with 'under-developed' countries. At the level of economic theory, the dominance of the rational-agent, competitive equilibrium model made it harder to make a theoretical case for permanent demand deficiency (some new classical macroeconomists went so far as to deny even short-term shortages of demand). And secular stagnation was never far from politics for it was closely connected to politically contentious arguments for allowing the level of government debt to rise. That is still true today.
Backhouse, R E, and M Boianovsky (2015), "Secular stagnation: The history of a macroeconomic heresy", working paper.
Domar, E D (1944), "The 'burden of the debt' and the national income", The American Economic Review, 34(4): 798-827.
Hansen, AH (1939) "Economic progress and declining population growth", The American Economic Review, 29: 1-15.
Klein, L R (1947), The Keynesian Revolution, New York, Macmillan.
Patinkin, D (1948), "Price flexibility and full employment", The American Economic Review, 38: 543-64.
Samuelson, P A (1948-67), Economics: An Introductory Analysis, New York, McGraw Hill.
Summers, L (2014a), "Reflections on the 'new secular stagnation hypothesis'", in C Teulings and R Baldwin (eds), Secular stagnation: facts, causes and cures, 27-38.
Summers, L (2014b), "US economic prospects: secular stagnation, hysteresis, and the zero lower bound", Business Economics, 49: 65-73.
Teulings, C, and R Baldwin (eds) (2014), Secular stagnation: facts, causes and cures, CEPR, London.