Recently, Lawrence Summers, writing in the Financial Times, has rightly suggested that we could possibly be experiencing secular stagnation.
This is a new suggestion that warrants consideration by all.
The comments below are intended to be no more than an initial reaction to the issue raised by Professor Summers.
Whatever the cause, it is indisputable that many economies, including Japan, the United States and many countries in Europe, are currently suffering from deficient aggregate demand.
This deficiency in aggregate demand has been increasing in many countries, and has been contributing to the worrying tendency toward deflation, despite years of quantitative easing in major economic zones.
There are many developments that could create a secular decline in investment, aggregate demand and economic activity generally. This note will focus on only one such possibility.
Business fixed investment is weak, but not due to a lack of profitability. In Japan, the United States and Europe the share of profits in national income has been increasing for more than three decades, and is now at record high levels. There is no need to reduce real unit labour costs, or to further lower real interest rate costs, as those parameters are not general constraints on business investment.
Let us further consider the declining share of labour income in national income. This trend is widespread, and the causes are not well understood. It is unusual, as in the post-war period, in the 1950s and 1960s, it was widely documented that most industrialised countries reported constant factor shares in national income. They were generally years of high employment and low inflation.
Relative to the total economy, declining household incomes, due to falling real wages, higher direct and indirect taxation and rising unemployment, must be contributing to declining consumer demand. Such developments combined could be a source of secular stagnation.
In the case of Europe, fiscal austerity including in Germany, wage restraint policies in Germany and elsewhere, and the massive current account surplus in Germany, are no doubt adding to the deflationary tendency spreading throughout Europe and beyond. The periphery is suffering greatly from the German orthodoxy.
Policy solutions have not been widely debated, particularly in Europe. We often hear that there are supply-side problems and that structural reforms and increased private investment will drive the economy forward. Well, supply-side reforms are necessary to increase productivity, but they do not necessarily drive-up demand and employment in the near term. And even with profitability high, no-one will undertake investment if consumer incomes and consumer demand are shrinking.
Monetary policy is at its absolute limit in so far as interest rates are concerned. Some commentators may want to see even lower real interest rates; but nominal and real interest rates have been declining for a decade or more (real interest rates have recently been negative) and those declines have not been effective in raising business investment or consumption.
Fiscal policies are in austerity mode for fear of raising already excessive levels of public debt. Arguably, as IMF analysis suggests, such policies are also contributing to weak demand and possibly, therefore, to secular stagnation.
Declining populations and workforces in some countries are also contributing to lower incomes, the strike of private investment and to general stagnation.
Arguably, there is only one monetary and fiscal policy combination that is powerful enough to check the tendency toward secular stagnation. That policy is overt money financing of budget deficits.
Overt money financing (helicopter drops), if executed properly, can add to household incomes without raising public debt or interest rates. If wages policy could be deployed to raise wages, where appropriate, then that would also add to demand stimulus.
Through those channels there is a considerable probability that recessions, depressions, deflation and any secular decline could be arrested, and reversed. Those policies have the potential to address price and wage imbalances, add to household incomes, stimulate demand, put economies onto a higher growth trajectory and take them back toward full employment equilibrium.