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Secular Stagnation

A state of little or no economic growth

What is Secular Stagnation?

The term “secular stagnation” refers to a state of little or no economic growth – in other words, an environment where the economy is essentially stagnant. “Secular” in this context simply means “long term.” The term was invented by Alvin Hansen in the 1930s, during the Great Depression, and was revived largely by Lawrence Summers.

Summers is a Keynesian economist who previously held the position of Chief Economist of the World Bank. He also served as Treasury Secretary under President Bill Clinton and as Director of the National Economic Council under President Barack Obama.

 

Secular Stagnation
Fig.1. Sectoral Balances in the U.S. Economy 1990-2017

 

Summary

  • The theory of secular stagnation was first put forward in the 1930s, during the Great Depression, and more recently revived by economist Lawrence Summers, who served as an economic advisor in both the Clinton and Obama administrations.
  • The primary tenets of the theory are that the lack of investing, due to an increased tendency toward saving, and the lack of an aggressive (i.e., high spending) government fiscal policy are the primary causes of a state of economic stagnation, where there is little discernible economic growth.
  • Opponents of the secular stagnation theory argue that the theory’s alleged condition of exaggerated saving is largely a myth and that the true culprit holding down economic growth is increased government regulation and fiscal intervention.

 

A State of Secular Stagnation?

Summers wrote numerous articles following the 2008 Global Financial Crisis to support his view that the economy is in a state of secular stagnation, correctly pointing out that the recovery during the Obama Presidency was the slowest recovery from a recession in history. Economic growth continued to fall well short, over the years, of projections by the US Congressional Budget Office, and interest rates have remained excessively low – even going negative in the European Union – for several years.

 

Summers’ Theory of Secular Stagnation

Summers briefly explained his theory of secular stagnation in a 2016 article, “The Age of Secular Stagnation.” In the article, he states, “The economies of the industrial world, in this view, suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. The result is that excessive saving acts as a drag on demand, reducing growth and inflation, and the imbalance between savings and investment pulls down real interest rates.” He goes on to assert that this tendency toward hoarding rather than investing comes from, “increases in inequality and in the share of income going to the wealthy… and a greater accumulation of assets by foreign central banks and sovereign wealth funds.”

Summers further adds that significant economic growth now only comes as a result of, “… dangerous levels of borrowing that translate… into unsustainable levels of investment (which in the instance of the 2008 financial crisis emerged as a housing bubble)” – in other words, as a severe overreaction to the overall tendency toward saving over investing.

 

The Solution to Secular Stagnation

Summers urges a two-pronged approach to solving the problem of secular stagnation, with both prongs aimed at increasing the demand side of the economy. The first thing he proposes is government fiscal policy that spends aggressively, particularly on things such as infrastructure and developing alternative energy sources. Advocates of the secular stagnation theory express little to no concern over increasing government debt, effectively suggesting that it is necessary to sustain economic growth.

However, it’s worth noting that the actions undertaken by the Obama administration, which included massive government investment in alternative energy, resulted in little more than increased federal debt without any noticeable improvement in the economy. For example, there is the infamous Obama investment of $535 million in Solyndra, a solar energy company which, in the end, did nothing but go bankrupt.

Summers also advocates decreased government regulation of businesses as a means to boost the economy. He was a strong supporter of the repeal of the Glass-Steagall Act in the 1990s, which had previously separated commercial and investment banking activities – requiring banks to choose one or the other but barring them from working in both fields. However, Summers also holds the apparently contradictory position that the economy would have benefitted from the Dodd-Frank Act, which drastically increased government regulation of financial institutions, being passed into law many years earlier.

 

Problems with the Theory

Nowhere near all economists embrace the theory of secular stagnation. It is a highly-charged opinion politically, by virtue of arguing in favor of ever-increasing government debt as the “only” way to maintain anything close to full employment and economic growth.

There are several obvious problems with the theory. For one thing, by the theory’s own tenets, the years immediately prior to the 2008 financial crisis should have been characterized by high unemployment and slack economic growth, but they were not. Secondly, the theory’s basic contention that the economic stagnation stems from a tendency toward saving rather than investing is highly questionable. Several studies indicate that savings rates are, in fact, considerably lower than they were in the 1980s and 1990s, which were periods of economic boom.

Additionally, Summers, in recent years, argued that the state of secular stagnation was so severe that no amount of economic stimulus could return the economy to full employment. However, in fact, employment rates under the Trump administration rose to record highs across the board, and without pursuing a fiscal policy of increased public money stimulus.

Opponents of the theory argue that stalls in economic growth are primarily the result of government over-regulation, as exemplified by the Dodd-Frank Act and the Affordable Care Act. This would seem to be supported by the fact that under the more laissez-faire approach of the Trump administration, the rate of investment has risen and the pace of economic growth has picked up considerably, increasingly nearing the 3.0% GDP growth rate that eluded the economy during the entire eight years of Obama’s presidency.

 

Additional Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of the financial industry, we highly recommend the additional CFI resources below:

  • Dallas Trimmed Mean
  • Economic Depression
  • Keynesian Economic Theory
  • Stagflation

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