The concept of secular stagnation, first propounded by Alvin Hansen in the 1930s, has enjoyed an academic – and mainstream – resurrection thanks to Lawrence Summers (2014, 2016), who first advanced the theory as an explanation for the subdued recovery and anaemic growth prospects of advanced economies. A surprising criticism recently came from Joseph Stiglitz (August, 2018), who believes that the theory offers a convenient escape away from assuming responsibility for failed policy during the crisis.  An acrimonious debate between Summers and Stiglitz followed.  

On the face of it, Summers – and Gauti Eggertson – are right: the modern theory of secular stagnation does see a central and substantial role for fiscal policy. The problem, however, lies in the fact that a short-term fix for aggregate demand shortfalls – fiscal policy – is being advanced as a long-term solution of the problem of reduced growth prospects. The central question of what drives investment in a capitalist economy is not addressed.

Secular Stagnation: Excess Savings in a New Keynesian Framework

The modern theory of secular stagnation is essentially a theory of excess savings. It is situated within the Wicksellian framework, where investment and savings at full employment are equilibrated by the natural rate of interest. The presence of cash implies that interest rates cannot be negative. When the natural rate of interest is negative, and nominal interest rates are constrained by the zero lower bound, real interest rates cannot be brought in line with the natural rate. In such a situation, excess savings generated due to factors such as demographic change or excessive savings in developing economies cannot get absorbed by investment, leading to stagnation.

However, the modern framework of secular stagnation situates Wicksell’s theory in a New Keynesian framework. The framework thus adopts a pre-Keynesian view, wherein the interest rate, rather than income, is believed to adjust investment and savings. In standard New Keynesian models, the Euler equation shows how the real interest rate determines inter-temporal consumption.

At non-negative interest rates, savings today cannot fail to be manifested in tomorrow’s aggregate demand, since the only purpose of current saving is to carry consumption from today to the future. The capitalist system is seen as an inherently rational system, whose chief goal is to provide for consumption, and only institutional specificities – the presence of cash and non-negative interest rates – keep it from achieving full employment. In such a situation, fiscal policy and government spending is required to raise the level of aggregate demand.

Keynes’ highlighting of the power of animal spirits and the forces driving investment have been ignored. Investment demand is autonomous, according to him, and could fall even at positive rates due to uncertainty or adverse expectations. Given a certain amount of savings – determined by savings habits and the distribution of income – a fall in investment would imply greater leakages of demand out of the system rather than injections into it, and hence a reduction in aggregate demand, output and employment. This situation could not be remedied through the manipulation of interest rates alone. Fiscal policy would be required even at positive interest rates in the face of aggregate demand failures in the short-term.

It is unclear whether fiscal policy can work as a long-term solution when the rate of investment is chronically depressed. In fact, it is ironic that the modern theory of secular stagnation focuses so heavily on the role of interest rates, given that Alvin Hansen himself wrote that “…the role of the interest rate as a determinant of investment has occupied a place larger than it deserves in our thinking” (Hansen, 1939, pg 5).

More Malthus than Keynes in New-Keynesian Secular Stagnation

The modern theory of secular stagnation owes more to the underconsumption theories of Malthus and Hobson than Keynes. Those theories too assumed that the primary outcome of the capitalist process is providing for consumption, and any constraint to consumption would lead to stagnation and slow growth. The difference is that while the modern theory sees the constraint as arising from purely monetary factors, the under-consumptionists assumed it arose from class dynamics in a capitalist society. Malthus held the loss of “unproductive consumers” responsible while Hobson highlighted the dangers of falling wage shares for labour.

Bleaney (1976) highlights the chief problem of under-consumption theories that is a central weakness of the modern theory as well; there is no explanation of the factors driving investment. If profits can be generated through the production of machines to make machines, or through armament production, then investment will be carried out and aggregate demand will not face any shortfall. Such production may not be strictly rational in that consumption is ignored, but, as Kalecki pointed out, capitalism is not a rational system.

The question posed by the modern stagnationists – whether a positive trend rate of growth can be assumed irrespective of cyclical fluctuations – is an important one, though the answer they provide is insufficient. Growth models like Solow’s assume that the trend rate of growth is determined by exogenous factors, namely the rate of growth of population and Harrod-neutral technological progress. But that answer arises from a model that assumes away the problem of deficient aggregate demand in the long-run.

What Drives Capitalist Growth?

Conceptualising investment as being determined by exogenous factors opens up new and exciting fields in the study of capitalist growth. Using an autonomous investment function, Kalecki (1962) showed that the only stable long-run growth rate of a capitalist economy was zero, with a positive trend arising only due to the operation of exogenous factors termed innovations. These innovations are not merely to be thought of as technological changes, but could also be inventions, the discovery of new sources of raw materials and markets, changes in institutions etc.

Innovations, interpreted in a broader context, are central to growth in Schumpeter’s vision. Schumpeter believed that Keynes’ pessimism with regards to the motives for long-run growth stemmed from the fact that the factors that gave rise to investment opportunities, such as technological changes, “…new sources of food and raw materials…” were being closed off to the developed capitalist world, while the saving habits of the bourgeoisie continued unabated (Schumpeter, 1946, pp 500-501).

Schumpeter’s diagnosis of stagnation is due to a specific form of evolution of capitalist society rendered moribund due to monopolies and attitudes towards risk-taking, while the criticism of Kalecki is more far-reaching: any form of capitalist society is prone to stagnation unless suitable exogenous factors are in operation. In his seminal article laying out the framework of secular stagnation, Hansen was pessimistic about the future prospects of growth because he did not believe that the pace of technological progress was smooth, and found no grounds to assume that capital-intensive, technologically sophisticated sectors such as railways and automobiles would emerge at a rate sufficient for the maintenance of a high inducement to invest consistently and uniformly through time.  

In conceptualising of capitalist growth of being driven solely by consumption, and in tying aggregate demand to the working of interest rates alone, the modern theory of secular stagnation assumes short-term fixes can solve a long-run problem. Shifting the focus from consumption and excess savings to autonomous investment flips the central question entirely: the question to be asked is not what constrains capitalist growth, but how did it ever manage to grow in the first place?

References

Bleaney, M. F., 1976. Underconsumption Theories: A History and Critical Analysis. London, Lawrence and Wishart.

Eggertson, G. & Mehrotra, N., 2014. A Model of Secular Stagnation. NBER Working Papers, no. 20574.

Hansen, Alvin, 1939. Economic Progress and Declining Population Growth. The American Economic Review, vol 29, no 1, 1-15.

Kalecki, M., 1962. Observations on the Theory of Growth. The Economic Journal, vol. 72, no. 285, 134-153.

Schumpeter, J. A., 1946. John Maynard Keynes 1883-1946. The American Economic Review, vol. 36, no. 4, 495-518.

Summers, L. H., 2014. U.S Economic Prospects: Secular Stagnation, Hysterisis, and the Zero Lower Bound. Business Economics, vol. 49, no. 2, 65-73.

Summers, L. H., 2016. Secular Stagnation and Monetary Policy. Federal Reserve Bank of St Louis Review, vol. 98, no. 2, 93-110.

Photo: National Archives at College Park. Unemployed Men Queued Outside a Soup Kitchen in Chicago During the Great Depression.

Rahul Menon is Assistant Professor in Economics at the Tata Institute of Social Sciences, Hyderabad, India.