Farewell Secular Stagnation

Marc Andreessen recently looked at the arguments for and against secular stagnation. He cited my Washington Post article when examining the case against secular stagnation. One of the points I make in it is that the proponents of secular stagnation incorrectly invoke the long decline of real interest rates as prima facie evidence for their view. Where they go wrong is that they look at real interest rates without accounting for the long decline in the risk premium. Once the risk premium is stripped out of their real interest measure there is no downward trend in real interest rates. Rather, you get a stationary risk-neutral real interest rate measure that averages close to 2%. This can be seen in the figures below, drawn from my follow-up article with Ramesh Ponnuru:

Interestingly, this risk-neutral measure closely tracks the business cycle and suggests it was the severity of the Great Recession and not secular stagnation that explains the low interest rates over the past six years:

Given this business cycle-driven relationship, the recent spate of good economic news points to rising interest rates in 2015. In fact, the daily measure of the risk-neutral nominal 1-year and 10-year interest rates from Adrian, Crump, and Moench (2013) show just that. See the figure below and note that 2014 has seen a trend change in the path of neutral interest rates. If this continues--and the improved economic news suggests it will--then the Fed will have to raising its interest rate in 2015.

I bring all of this up as a way to motivate a prediction for 2015: secular stagnation will fade from the national conversation for the U.S. economy. Instead, the conversation will focus even more on how to handle the advent of an increasingly digitized, automated economy where productivity growth is rapid and neutral interest rates are rising. Secular stagnation, in other words, is about to experience the same fate it had when it was first pushed in the 1930s. Here is what Ramesh Ponnuru and I wrote about that experience:

"The business cycle was par excellence the problem of the nineteenth century. But the main problem of our times, and particularly in the United States, is the problem of full employment. . . . Not until the problem of the full employment of our productive resources from the long-run, secular standpoint was upon us, were we compelled to give serious consideration to those factors and forces in our economy which tend to make business recoveries weak and anaemic and which tend to prolong and deepen the course of depressions. This is the essence of secular stagnation— sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.” 

Thus wrote Alvin Hansen, a professor of economics at Harvard, in 1938. Slow population growth and the deceleration of technological progress, he argued, was leading to slow capital formation and weak economic growth. A program of public expenditures, though it had its dangers, was probably required to avoid this fate. 

Hansen’s article was of course spectacularly wrong as a guide to the next few decades. Instead of suffering through stagnation we entered an extended, broad-based, and massive economic boom. In hindsight we can see that his analysis, while thoughtful and intelligent, was unduly influenced by the depression he was living through, and can see as well that the depression was the result of specific policy mistakes rather than inexorable trends. Recent research by Alexander J. Field shows that the 1930s were actually a time of exceptionally high productivity growth. 

Hansen’s worry, some of his specific arguments, and his phrase “secular stagnation” are all making a comeback in our own day. Lawrence Summers, like Hansen an economics professor at Harvard, has sounded an alarm about the ability of industrial countries to achieve adequate economic growth. A new e-book, Secular Stagnation, includes chapters by Summers and other leading economists discussing the question. 

The fact that Hansen was wrong does not prove that contemporary stagnationists are. In this case, though, history is repeating itself rather exactly. We do not pretend to know what the future path of economic growth in the United States will be. But the case for stagnation is weak—and, as in the 1930s, it is getting undue credence because of a long slump caused by policy mistakes.

Farewell secular stagnation. Hello the second machine age.