More on Summers, Taylor, and Secular Stagnation

January 6th, 2014 at 1:30 pm

I appreciate the fact that John Taylor responded to my recent critique of his WSJ oped debunking the Summers’ thesis of secular stagnation.  It’s also timely in that Larry has another piece on the issue that’s worth reading in today’s WaPo.

With respect to John–we often disagree but I think we do so without being disagreeable–I didn’t think his response to me was…um…responsive.  His main argument is that since I didn’t address the decline in the equilibrium interest rate, we’re talking past each other.

…to my surprise, I see that [Jared] does not even mention the decline in the equilibrium interest rate which is at the heart of the view that Larry put forth.  So Jared’s response has missed the main point of the argument between Larry and me, and I’m disappointed that there’s not much to respond to in that regard.

I’m confuzzled.

Both John and Larry (and myself and everyone else who talks about this) frame the issue in terms of weak output, high unemployment, low investment and the decline in potential GDP, even in the face of very low interest rates.  John refers readers to a recent piece he wrote on the issue, in which the abstract begins:

In recent years the American economy has been growing very slowly averaging only 2 percent per year during the current recovery. The result has been stagnant real incomes and persistently high unemployment.

Summers’ oped today begins the same way, pointing to weak output and unemployment even in the face of very low rates.

The interest rate point is diagnostic: a near-zero Fed funds rate since 2009 amidst this continued weakness leads Larry to worry about secular stagnation and John to worry about the ACA, Dodd-Frank, et al.  No one, John included, denies the fact of the near-zero FFR and the weak recovery.

Larry then emphasizes a very common macroeconomic argument these days that the equilibrium rate needed to clear the output market is a few points below zero.  I’ve stressed this point in lots of other posts (most recently here) and again consider it basic diagnostic logic based on IS-LM relations at the zero bound and the empirical rule of thumb by none other than Taylor himself.

I entered the argument viewing this diagnostic as given and objected to John’s WSJ oped based on his following two points, one about now, the other about the last business cycle.  I think the current problem is weak demand; he thinks it’s those bad Obama policies that House Republicans are always trying to repeal.

He thinks the booming 2000s cycle is evidence against secular stagnation.  I agree with Larry’s point that “even a great bubble wasn’t enough to produce any excess in aggregate demand.”  As I stressed in my original post, employment and growth were notably weak in those years, with significant negative consequences for middle and low-income families.

Yet in his short pushback to my post he seems to be saying that all that other stuff about demand and jobs and the heretofore weak recovery is “another secular stagnation thesis.”

In fact, I think we’re talking about the same thesis.  Nor does he offer any defense for his case that it’s ACA, Dodd-Frank, and bad fiscal and monetary policy that are currently holding things back.  He neither addresses my arguments nor those offered by Brad DeLong et al here.

So I too am disappointed.   I’m happy to argue about the extent of the decline in the equilibrium interest rate, but we can all see that an FFR at zero hasn’t “cleared the market.”  My (and Larry’s, Brad’s, Paul’s et al) “why not” has to do with inadequate demand.  John’s “why not” has to do with policy uncertainty.  That’s the debate.

Print Friendly, PDF & Email

9 comments in reply to "More on Summers, Taylor, and Secular Stagnation"

  1. smith says:

    Take the Brad DeLong idiot’s test:
    1 Why is housing investment still so far depressed below any definition of normal?
    – Because there are over 1 million homes in some state of foreclosure.
    2 Why has labor-force participation collapsed so severely?
    – Lack of work, duh
    3 Why the very large spread between yields on safe nominal assets like Treasuries and yields on riskier assets like equities?
    – Irrational exuberance and the investment-industrial complex (bloated financial sector)
    4 Why didn’t the housing bubble of the mid-2000s produce a high-pressure economy and rising inflation?
    – Investment in land and buildings produces nothing, vs. investment in businesses that sell services and products.
    5 To what extent was the collapse of demand in 2008-2009 the result of the financial crisis and to what extent a simple consequence of the collapse of household wealth?
    – Totally the financial crisis and rising unemployment, job losses Oct 2008 – Jan 2009 were historic
    6 Why has fiscal policy been so inept and counterproductive in the aftermath of 2008-9?
    – Larry Summers shorted the stimulus by 50% due to worry over bond vigilantes (per Krugman) Pelosi insisted on tax cuts, Obama is no Roosevelt.
    7 Why hasn’t more been done to clean up housing finance (in America) and banking finance in Europe)? Bank lobbyists “They own the place” (Dick Durbin) The top 25% who run the country (Democratic politicians included) benefit from low interest rates and depressed housing prices, and slack labor market.

    An idiot could figure this out.

    Also the Larry Summers agenda is conservative, using code words for policies he advocates more clearly in other forums, like cutting corporate taxes. He advocates “reform of social insurance”, afraid to say cutting social security, medicare, and medicaid?

    No mention of debt relief (mortgage, personal, and student), minimum wage, or strengthening labor. Make banks eat principal, put a 15% interest cap on personal debt, stop the Fed government profiting $50 billion/year off student debt. Cut work hours and end exempt status. Break up the banks. Raise corporate taxes, they either expand (hiring is an expense) or some of their enormous cash to finance gov spending on infrastructure.
    Restore 90% rates on income over $2 million.

    • Dave says:

      We’ll never be fooled by Clinton’s forces again, but let’s not call people idiots, please.

      This is only easy to understand if you’re in touch with facts. This is very difficult to understand for 99% of the people, including many in finance, accounting and even economics.

      The people who cannot see it aren’t dumb, necessarily. They’re just gullible.

  2. Dave says:

    I wish mainstream economists would begin talking more about the theoretical nature of the ‘equilibrium interest rate’.

    This is a theoretical creation. When you look deep at the mechanisms behind the effect upon aggregate demand from the equilibrium rate, you see in recent times it depends highly upon household debt. I challenge the idea that a negative rate could fix this problem, because a negative rate cannot necessarily shove more debt upon the over-indebted households.

    I think we should erase the graphs of IS-LM below the point where they cross zero. It isn’t just theoretical, it is nonsense.

    • smith says:

      I’ve made a point related to this previously. Krugman (and perhaps others) argue for higher inflation (of say 4%) to provide a backstop against reaching the zero lower bound before the economy can recover. His point is with the ability to drop interest rates quickly to 4% vs. 2%, this could rescue recovery more effectively in a steep downturn. My point is probably not. Lower interest rates are used to aid recovery by promoting big ticket purchases like homes, new homes, new cars, new appliances for new homes. Might not work where homes are causing the recession. It certainly makes a difference to buyers even in a down market. The difference is 2%. 4% – 2% = 2% extra play to lower interest. How big a difference would that make? Just look at the difference going from 2% to 0% made, not much. One could claim there is a threshold somewhere between 2 and 4% reductions that once crossed would arrest the downward spiral in sales and prices. Deflating buyers might be tempted to lock in low prices and interest before the minimum. Probably not. Realtors were trying that line in 2007. More likely we’d get the same scenario, taking a little more time to reach 0, but getting there nonetheless. Many however would then be locked into higher interest rates, and be unable to recast, making their debt situation much worse. The rich could take full advantage of low rates making, inequality worse. It’s happening right now. And inflation would eat away at labor’s wages in good times. Heads they lose, tails they lose. Inflation is not the answer.

  3. readerOfTeaLeaves says:

    If Taylor were correct, then it seems that countries without Dodd-Frank or ACA would be pulling out of the economic doldrums. However, western democracies are struggling, and all seem to have the same problem: too few jobs.

    If Taylor thinks that the 2000 housing boom ‘argues against secular stagnation’, then he’s missing some other factors: housing was the way that Americans were trying to protect themselves financially. Pensions are diminished, 401(k)s are subject to market distortions, and savings were not paying much interest. So too many people, some out of greed – and others out of desperation – sunk their money in houses and real estate.

    This points to a deeper problem, which I would call ‘economic insecurity’. It happened in part because so many things were deregulated, and also when companies were bought out or went bankrupt, employees were left with nada. Hence, putting money into housing was a strategy based on the assumption that the price of a house in the 2000s was more ‘secure’ than other forms of wealth or income, including pensions and savings plans.

    Consequently, far too much money was tied up in real estate. (In many households, well over 33% percent of income was devoted to rent/mortgage. Sen. Eiiz Warren has done yeoman’s work explaining and documenting this problem of how the middle class has been eroded by housing costs: See Also, “The Two Income Trap”). That disproportionate amount of income going to mortgages and rent left consumers with less to spend in the US economy.

    I understand that the US economy is supposedly 70% driven by consumer spending.
    If people don’t have money to spend, in part because they are desperately trying to hold onto a ‘real asset’ like a house, then the consumer economy gets hammered. Add in escalating costs for medical care, and you get a double-whammy.
    Which means that Summers’ analysis that there is a serious demand problem, and has been for at least the past decade, is spot-on.

    Until Taylor stops to ask *why* the housing bubble happened in the way that it did, and at the time that it did, he’s really missing how the American middle class has been economically undercut the past 30 years.

    IMVHO, the housing bubble was partly driven by greed (certainly in Wall Street and large lenders). However, I suspect that in large part, in terms of individual behavior, it was a symptom of reduced confidence in institutions (pensions, company retirement accounts). People tried to look out for themselves by buying real estate. All that economic activity in the housing part of the economy increased the FIRE sector, which morphed into about 40% of US GDP in the 2000’s. In other words, economic insecurity (and greed) created terrible feedback loops that circled back on themselves, growing the FIRE sector larger, and larger, and larger as a percentage of US GDP.

    How on earth is a FIRE sector that is 40% of GDP providing: (1) enough skilled jobs, (2) an economically stable distribution? (Okay, rhetorical question. My bad…)

    I admit to being morbidly fascinated that Taylor fails to recognize the housing bubble as further evidence that actually supports Summers’ argument for secular stagnation.

    Taylor doesn’t seem to be looking at the types of economic activity that were prevalent in the 2000s, irrespective of ‘equilibrium interest rates’. In the 2000s, offshoring was rampant, the economy was becoming financialized (on steroids, and Summers is culpable in that shift), and people were being laid off.

    My personal recollection of the 2000s includes teaching some community college courses to a whole lot of laid-off Boeing employees, and also (later) unemployed construction workers. The Boeing employees, almost to a person, were *incredibly* anxious about their futures, and convinced that they would *never* again make the kinds of income + benefits they’d made on the Boeing production lines. These people had families, most of them had terrific work ethics, they were open to learning, and they wanted — **desperately** wanted — j-o-b-s. They wanted decent employment; not one of those guys wanted to be on welfare, which to them would have been the equivalent of total humiliation. (IMVHO, the idea of being on welfare was psychologically catastrophic for the students that I’m thinking of, men and women in their 40s and 50s, with many years’ work experience, having to go out into the job market for the first time in years.)

    Having seen grown men with over 20 years work experience, who were traumatized by layoffs, I really get irate when I read things like Taylor’s claims that ACA and Dodd-Frank explain an economy in the doldrums.

    Taylor’s analysis completely leaves out factors like 9-11 and the serious economic consequences that followed it (at least, for aerospace). He is also leaving out the increasing loss of faith in institutions, the erosion of pension benefits, and the hugely escalating costs of health care — all of which sucked money away from consumption.

    And if there’s not enough consumption, there’s not enough demand.
    And if there’s not enough demand, there aren’t enough j-o-b-s.

    To reiterate: what Taylor interprets as evidence against Summer’s claims of secular stagnation is actually supporting Summers’ analysis.

    I sincerely wish Mr. Taylor would read “Race Against the Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy.” If their predictions of a winner-take-all structure to the economy is correct (and I suspect that it is) then Summers’ analysis is only going to be more important moving forward.

    • Perplexed says:

      Good points, all.

      You touch on a couple of things I have brought up in prior comments that I believe have played, and continue to play an outsized role in the crises and its aftermath but are seldom addressed in “approved economic conversations,” e.g.:

      -“This points to a deeper problem, which I would call ‘economic insecurity’. It happened in part because so many things were deregulated, and also when companies were bought out or went bankrupt, employees were left with nada. Hence, putting money into housing was a strategy based on the assumption that the price of a house in the 2000s was more ‘secure’ than other forms of wealth or income, including pensions and savings plans.”


      “However, I suspect that in large part, in terms of individual behavior, it was a symptom of reduced confidence in institutions (pensions, company retirement accounts). People tried to look out for themselves by buying real estate.”

      Both of these items are “connected” by the public’s perception of risk in the real estate market, and the government’s role in protecting this market from fraud. What the “agreed” (by economists, bankers, and plutocrats anyway) description of what occurred is a “bubble” (technical term I guess, although I’m not sure exactly what defines it and how we know “scientifically” what is and isn’t a “bubble.” IMHO its a “tell” when economic “scientists” use children’s terms to describe what’s happening e.g. bubbles, sticky prices, etc.) If the role of “counterfeit mortgage fraud” were more accurately portrayed in these explanations, the degree to which the public trust in government to protect these markets was violated by the crisis, and the aftermath (e.g. selling indulgences to criminal banks), could be more accurately and openly discussed. The highly leveraged real estate investments being sold as the “American Dream” have never really been “suitable” investments for most Americans. If your stock broker sold you such an un-suitable investment and you lost an enormous amount of money due to fraudulent activities of other market actors, you could sue and collect damages. The ONLY thing making residential real estate even remotely “suitable” for most Americans is Government oversight of the market to insure that its free from fraud. This was the mistaken assumption of most American residential home buyers; they were exposed to risks of counterfeit fraud that they “assumed” that the Government would protect them against in their housing investments. (Have you noticed the lack of “economic science’s” interest in determining the “limits” to which the “bubble” could have grown without the funding made available by the counterfeit fraud? Probably not important enough to study I suppose.) Furthermore, those with substantial investments in real estate now know that, not only will the Government not protect them from these frauds, they will insure that the losses are absorbed entirely by homeowners and that the fraudsters will not even be prosecuted and forced to relinquish their ill-gotten gains. This increases the already substantial risk enormously; and now American homeowners perceptions of the real risk are closer to the reality of the risks they actually face then they were before. They, quite accurately I’d guess, perceive that their home equity (for the few who really have much equity) is at much greater risk than they believed in the past, and that high levels of spending are maybe not the best for their financial security (at least for those who still have enough income to choose to have some savings).

  4. bakho says:

    Taylor is probably correct that interest rates were too low in the 2000s. Why were they too low? The Bush administration enacted maximum tax cuts for the wealthy but did way too little shore up the states, help displaced workers. There were tax cuts but too little job creation. In short, monetary policy was loose, but fiscal policy was woefully inadequate.

    Currently, we have the same problem: Inadequate fiscal policy and domestic job creation.

    The interest rates are too low, but that is a response to bad fiscal policy. OTOH, the interest rates that consumers pay (credit card and student loan) are much too high given the low level of inflation.

    Taylor’s recommendation assumes that we have adequate fiscal policy. We don’t.

    The best monetary policy cannot adequately compensate for bad fiscal policy. This best explains why no one has an adequate monetary policy proposal. Milton Friedman developed his theory in a period when fiscal policy was adequate and it gave the false notion that fiscal policy does not matter. Now that fiscal policy has been bad for a decade and a half, we find that monetary policy without adequate fiscal policy is impotent.

  5. george kaplan says:



    AND SO ON.




  6. Perplexed says:

    -” I’m happy to argue about the extent of the decline in the equilibrium interest rate, but we can all see that an FFR at zero hasn’t ‘cleared the market.'”

    So why is it that all of our great economic economic “thinkers” work so hard to develop theories and models to explain what is so obvious to other logicians and mathematicians? Just why is it so “dear” to the “science” of economics that there MUST be some theory that works to explain how we can have “markets” and also have, simultaneously, the legal ability to exclude people from those markets? Do economists so fear actual markets that they know,JUST KNOW, that there MUST be some way to have “markets” that are not really markets? Markets that don’t clear is an oxymoron; there will never be a theory explaining how they work that doesn’t involve a changing definition of the word “markets,” but the search for “the Holy Grail” explanation will continue unabated and employ economists long into the foreseeable future.

    Labor “markets” don’t clear because “labor” is exempt from the 1914 Clayton Act anti trust provisions. Labor “markets” don’t clear because we allow tyranny of the majority and don’t enforce Constitutional provisions “insuring” “equal protection under the law.” Those whose product is “labor” (the 95%) are powerless against the buyers of their “product” because they lack equal protection under the law which allows them to be coerced by preventing laborers from “pooling their risk” of being unemployed and empowering employers to decide “at will” which “producers” of labor will be “excluded” from “market” participation and bear the entire cost with no ability to spread the risk. The Clayton Act is coming up on its 100th anniversary this year; That’s 100 years of “market” exclusion, employee coercion, and full employment for economic “scientists.” Maybe we should celebrate the anniversary be renaming the Clayton Act, the “Economists’ Full Employment Act.” While one would think that economists as a group would be the most ardent protectors of actual free markets, this tyranny of the majority could not survive without their collective defense of the tactic. What we need are some mathematicians who can measure and show some “charts” of the accumulated damage to victims of this tyranny over the last 100 years.