“When you write down all the good things you should have done, and leave out all the bad things that you did do, that’s memoirs” – Will Rogers
“Secular stagnation” is doing the rounds as a theory of why we’re in the mess we’re in, after this Larry Summers talk, which Paul Krugman is claiming basically summarises ideas that he’d also been talking about for the last few years. I am not sure about the extent to which anyone can claim priority on this though – as Krugman says, Summers is basically giving a clear expression of a set of ideas which have been ubiquitous for a long time, to the extent that I was making jokes along that line, ten years ago. I will follow Krugman in saying that I also had been thinking about a similar explanation of things since 2009, set out in cursory form here and in greater detail here.
Basically, the thesis is that since about the mid-1990s, it has been the case that it has only been possible to achieve anything like full employment in America during periods when the private sector has been chronically over-consuming and increasing its debt levels. The “natural rate of interest” consistent with full employment has been consistently negative all that time, and since there are good theoretical reasons to presume that the natural rate of interest has some relationship to the natural rate of economic growth, this might be saying something rather depressing about the underlying growth potential of the developed world’s economy. And so on, and so forth.
Now it’s an interesting question, although not one on which I find myself with anything to say, as to whether we are stagnating secularly. But the thing I do want to address is that, in the way in which the issue is being discussed historically, there is a lot of rewriting of the recent past.
Right from the start, you can see that there has been a lot of semantic drift in the word “bubble”. From having once referred to a specific model of how prices could depart from fundamentals in a rational expectations model, to referring to any general inflation of securities valuations, Summers and Krugman appear to be using “a succession of bubbles” to refer to “any period during which personal gross debt increased based on rising asset values”. As an opponent of linguistic inflation, I’m already prejudiced against this way of thinking of the economic history of the last two decades. But in describing the growth in debt as if it was a purely exogenous phenomenon, due to nothing other than animal spirits and irrationality, there’s a really dangerous kind of mistake being made.
It was policy! For more or less the entire period in question (call them “The Greenspan Years”), the growth of consumer spending, financed by increased consumer debt, was the main instrument of policy. I suppose I might be misremembering but I really don’t think I am, and I was there and I read a lot of FOMC minutes. The US authorities wanted to manage aggregate demand, but during the entire period, the fiscal authorities had either a deficit reduction target (Clinton) or a massive unfunded war (Bush), and so they made the goal of interest rate policy the management of consumer demand. This consumer demand was financed by debt, but nobody paid attention to this, in my opinion largely because the idea of stock/flow consistency didn’t really feature in the economic models they were using.
So here’s my version of the economic history of the pre-crisis years, and I suggest it’s at least as consistent with the facts as the “secstag” hypothesis and has the advantage of having significantly fewer unexplained factors in it:
- China starts to industrialise and NAFTA is passed.
- This is experienced in the US economy as a step change in the marginal propensity to import, and a step change in the import component of investment (ie, outsourcing).
- It is decided, for lots of reasons (including geopolitical ones), and quite possibly correctly, that Chinese industrial policy ought to be accommodated by domestic exchange rate policy
- So there is a structural shortage of domestic demand
- Which is probably exacerbated by the distributional effects of Chinese imports and NAFTA
- For lots of reasons, but mainly the Clinton deficit target and the Bush war-financing constraint, fiscal policy is not used to make up the shortage of domestic demand
- The distributional effects are also not addressed by redistributive taxation because hahaha are you kidding me
Policy is now in a box. The Federal Reserve has got a basically deflationary economy to deal with, and a fiscal policy constraint that is non negotiable. It has to set policy to deal with this demand shortfall. This gives you all of the observables of the “secular stagnation” hypothesis without having to take any particular position on the (on the face of it unrealistic, remember the Internet?) question of whether the 1997-2005 period was one of technological stagnation. Back to the narrative.
- Interest rate policy is set to manage aggregate demand
- Because the import intensity of investment spending has gone through the roof, domestic consumption demand is much more sensitive to interest rate policy than domestic investment demand
- So, de facto, consumer spending and “consumer confidence” become the intermediate policy variables of interest
- American consumers increase their consumption spending by dissaving from their net wealth
- But the wealth in question is overwhelmingly housing wealth, so dissaving means taking on more debt
- The Bankers (I bet you were wondering when we’d get on to them) accomodate this policy goal
- But the fact is, you can’t get to an excessive debt ratio by responsible means, so the debt ratios of the US personal sector are in fact underpinned by a snake’s nest of silly and in many cases crooked financial instruments.
Oh yes, and to put the final cap on it, Alex Harrowell reminded me the other night that, as Doug Henwood demonstrated, in the USA the majority of that consumption growth was actually healthcare, so the consumption was basically non-discretionary in nature. Nice touch.
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.
And so, welcome to the world you made guys. These are the consequences of globalization, entirely predictable and in fact predicted (by Dean Baker, among others). The final conclusion is probably the same as if it was a mysterious secular stagnation; fiscal policy. But 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 really – there is no need to tell ourselves ghost stories about animal spirits. There’s no puzzle here. We got this outcome because we wanted it.
 As you can see, that link goes to the blog which I decided to make non-public, because people were being nasty to me. I’ll put up the text of the post in question on CT in a short while.
 Of course, conversely, someone who was pernickety about their Keynes might note that there are very good theoretical reasons to believe that there is no reason at all to suppose that the equilibrium rate of interest in the market is going to be the same number as the full employment rate of interest. The case in which the two coincide is a very “special” case; it’s precisely the fact that there’s no reason to suppose they will which caused Keynes to write his “General Theory” and indeed to give it that title.
 Doesn’t look like a proper word but I think it is.
 Oh dear.