Secular Stagnation and Wealth Inequality

March 23, 2014

Alvin Hansen introduced the notion of “secular stagnation” in the 1930s. Hansen’s hypothesis has been brought back to life by Larry Summers in his November 2013 secular stagnation speech. The speech generated a huge amount of discussion, and for good reason. Summers’ provocative hypothesis is that the Great Recession was symptomatic of a longer-term problem: persistently inadequate demand that is evidenced by low real interest rates.

The basic idea and implications have been fleshed out by many: here is some backround reading by Ryan Avent, John Cassidy, Gavyn Davies, and Paul Krugman. A brief summary of the hypothesis goes something like this: A normally functioning economy would lower interest rates in the face of low current demand for goods and services in order to induce households and businesses to borrow and spend. When interest rates fall in a normally functioning economy, households borrow to buy cars or re-do their kitchens, and businesses find it profitable to invest. A lower interest rate helps boost demand.

But what if the interest rate needed to generate sufficient demand is negative? In other words, what if the economy needs to charge people for saving in risk-free assets such as U.S. Treasuries in order to get them to spend? Many find this idea counter-intuitive: real interest rates are basically zero, but this argument says they are still too high.

Why would interest rates be stuck at too high a level? Why can’t they become negative? Nominal interest rates can never be negative because of currency — the U.S. government promises a nominal return of 0% if you hold cash and so no one would accept a nominal interest rate below 0% on another government security. Of course, real interest rates can become negative if we have inflation. But inflation may be hard to get, especially if a central bank has built a reputation for fighting inflation. If real interest rates need to be very negative to boost demand, but prevailing interest rates are around zero, then we will have too much savings in risk-free assets — what Paul Krugman has called the liquidity trap. In such a situation, the economy becomes demand-constrained.

The liquidity trap helps explain why recessions can be so severe. But the Summers argument goes further. He is arguing that we may be stuck in a long-run equilibrium where real interest rates need to be negative to generate adequate demand. Without negative real interest rates, we are doomed to economic stagnation.

Like most provocative ideas at their initiation, it is still mostly abstract based on informal modeling. There will no doubt be push-back from economists who are skeptical of demand-driven economic cycles, and we are likely to see more modeling and testing among researchers trying to flesh out the idea further. This is absolutely necessary. And hopefully it will be fruitful.

In our view, what is missing from the secular stagnation story is the crucial role of the highly unequal wealth distribution. Who exactly is saving too much? It certainly isn’t the bottom 80% of the wealth distribution! We have already shown that the bottom 80% of the wealth distribution holds almost no financial assets.

Further, when the wealthy save in the financial system, some of that saving ends up in the hands of lower wealth households when they get a mortgage or auto loan. But when lower wealth households get financing, it is almost always done through debt contracts. This introduces some potential problems. Debt fuels asset booms when the economy is expanding, and debt contracts force the borrower to bear the losses of a decline in economic activity.

Both of these features of debt have important implications for the secular stagnation hypothesis. We will continue on this theme in future posts.



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12 Responses to Secular Stagnation and Wealth Inequality

  1. Dan Mulligan on March 23, 2014 at 10:27 ami

    Isn’t this driven in large part by labor’s declining share of income/productivity growth? And then increased by deliberate policy choices, such as the tax laws (still love the phrase “carried interest”). So, a deliberate war o the middle and lower class?

    • Michael on March 24, 2014 at 12:03 pmi

      Absolutely! Demand can only come from borrowing for so long. When labor’s share began declining 30 years ago, debt started rising. In 2007, debt-fueled demand reached its limit. We now have an economy being driven by low wages without the help of increasing household debt

      Even though it’s about 20 years too late, it’s time to reverse our supply-side policies and get back to post-WWII era demand-side policies.

  2. Peter S on March 23, 2014 at 12:23 pmi

    May I suggest a close reading of the following Michaael Pettis post:

  3. Ryan on March 23, 2014 at 1:08 pmi

    Isn’t investment part of aggregate demand? Isn’t there a relationship between saving and investment? Obviously I need to read up on the secular stagnation thing, but it’s not immediately obvious to me that higher saving means lower demand over the long run.

    • Gumby on March 23, 2014 at 2:24 pmi

      In normal times when the economy is functioning properly, savings and investment should be roughly equal. That is, the goal is to converts the savings of the mass into investment by other masses. This usually takes place through financial intermediaries.

      There are several reasons why this has ceased to be the case. The standard Keynesian theory is that this is a self-reinforcing, somewhat unnatural equilibrium that can be escaped by forcing investment through government direction. This could possibly the case, and so given what we know, it would be prudent to try to convert all excess to savings through government borrowing and directed infrastructure spending.

      There are other theories also. The main one that seems to best explain the connection between inequality and stagnation is that the ‘savers’ actually have a bigger incentive to hold their assets than to attempt to grow them. Summers likes to explain this through the interest rate, and the assumption in that argument is that a higher real interest rate would force these savings out into investment because the savers can rationally expect to get a higher overall return by investing those savings when compared to the potential for inflation.

      There is, however, another, unknown factor that Summers has eluded to, which is that much of our saving class has ceased to be rational, such that higher real interest rate might not work either. This argument depends upon the idea that savers gain more utility through completely safe investment rather than the same risky investment with the same potential payoff. I think this always exists to some degree in every economy, that is, many savers cannot be adequately converted to rational investors through the intermediaries. This can be explained by transient fear, but it can also be explained by something Summers would probably call, “Political Savers.” That is to say, their goals are not necessarily to maximize gains, but rather to hold whatever it is they value by taking no risks.

      One explanation would be the accumulation of guaranteed intergenerational wealth.

      • Dave on March 23, 2014 at 7:58 pmi

        I think there also could be a problem that occurs with international finance, in that the investment across borders sometimes carries with it an implicit higher level of safety than domestic investment, depending upon the banks involved, the countries involved, and the types of investments. In normal times, with equally developed economies, cross investing might not be a problem. However, when some countries are pulling in investment through the perception of safety, whether that is a government guarantee or something else, and it eventually leads to over investment, asset bubbles and an eventual simultaneous pop, the investor pool in each country has grown accustomed to a much safer level of investment than should normally be available, thus you might see an adaptive response, a sudden loss of confidence and a complete change of investment strategy.

        Clearly many countries experienced asset bubbles at the same time, and as interest rates dropped everywhere, so too did the expectations for returns, but the demand for safety grew stronger. I don’t think this is the largest effect, but it could contribute.

        On top of it all, there is the trade deficit that definitely pushes down both wages and domestic investment. This, I believe, is a very significant factor.

    • Marko on March 23, 2014 at 4:04 pmi

      Investors are waiting to see an increase in demand before making investments. Consumers need the investment to occur first so that jobs will be provided , along with the income they need to consume.

      It’s a stand-off.

      • Richard on March 23, 2014 at 6:29 pmi

        Ergo the rationale for Keynesian-style stimulus spending, to break the standoff.

  4. George H. Blackford on March 23, 2014 at 2:23 pmi

    It seems to me that secular stagnation is tied to technology, specifically, mass-production technology. Mass-production requires mass markets, that is, large numbers of people who have purchasing power, and mass markets, in turn, require a mass-distribution of income.

    In the absence of a mass distribution of income, the only way full employment can be obtained in a mass-production economy is through producing for export or through the accumulation of debt relative to income, otherwise the mass quantities of goods that can be produced cannot be sold. Neither of these options is sustainable in the long run since producing for export requires that importing countries accumulate debt and eventually the accumulation of debt, whether domestically or on the part of importers, will overwhelm the system whichever option is chosen. (See: )

    I would further argue that there were three factors that contributed greatly to the economic prosperity that the U.S. experienced in the decades following World War II. The first was a dramatic decline in the concentration of income. The second was a dramatic increase in the size of the government relative to the size of the economy, and the third was a highly progressive tax structure.

    The second and third factors contributed to the first which, in turn, led to an expansion of the domestic mass markets that fueled our economy following the war, and it is worth noting that the expansion of government (especially, in areas such as education, policing, firefighting, regulation, emergency medical personnel, etc.) led to an expansion in areas of the economy in which mass-production technology played a minor role. In other words, the expansion of government not only contributed to employment through the expansion of mass markets by increasing demand and lowering the concentrations of income, but because it expanded the non-mass-production areas of employment in the economy.

  5. M. Krebs on March 23, 2014 at 6:41 pmi

    Here’s a simple, layman’s theory: People with money and jobs already have all the crap they need, in spite of having not had a real raise in almost forever. They have cars that last more than 10 years with regular maintenance, granite countertops, flat screen TVs, iPhones, all manner of cheap stuff made in China, etc. What are they supposed to “demand?” What we need, obviously, is more people with jobs and money. That and improved infrastructure. Wait, maybe we could build some stuff! Oh never mind, that’s just silly.

  6. Mitch on March 23, 2014 at 9:24 pmi

    Too many people are trying to hoard cash and save. If you are very lucky and make a lot of money you may not be interested in spending enough of your income to recycle that demand back into the economy. Check out this metafilter post:

  7. Olli Ranta on March 24, 2014 at 1:55 ami

    The concept of savings in GDP and macroeconomics seems to differ much from the common meaning of the word. It’s some hodgepodge related to investment, see

    Part of the mess is that retained earnings don’t seem to be necessary as banks really are able to create money, see