Larry Summers and Paul Krugman have recently identified the phenomenon of stagnation. Given that they are giants in today’s economic policy conversation, their views have naturally received enormous attention. That attention is very welcome because the issue is so important. However, there is also a danger that their dominance risks crowding out other explanations of stagnation, thereby short-circuiting debate.
Krugman has long emphasized the liquidity trap — zero lower bound to interest rates — which supposedly prevents spending from reaching a level sufficient for full employment. Summers has added to this story by saying we have been in the throes of stagnation for a long while, but that has been obscured by years of serial asset price bubbles.
That is a good start to the conversation, but there are other views that dig deeper regarding the causes of stagnation. For instance, John Bellamy Foster and Fred Magdoff clearly identify stagnation in their 2009 book The Great Financial Crisis: Causes and Consequences. They conclude with a section titled “Back to the Real Economy: The Stagnation Problem” and they write:
It was the reality of economic stagnation beginning in the 1970s, as heterodox economists Riccardo Bellofiore and Joseph Halevi have recently emphasized, that led to the emergence of “the new financialized capitalist regime,” a kind of “paradoxical financial Keynesianiasm” whereby demand in the economy was stimulated primarily “thanks to asset-bubbles.” (Foster and Magdoff, p.129)
My own 2009 New America Foundation report, “America’s Exhausted Paradigm: Macroeconomic Causes of the Financial Crisis and Great Recession,” concluded:
The bottom line is macroeconomic failure rooted in America’s flawed economic paradigm is the ultimate cause of the financial crisis and Great Recession. . . . Now, there is a grave danger that policymakers only focus on financial market reform and ignore reform of America’s flawed economic paradigm. In that event, though the economy may stabilize, it will likely be unable to escape the pull of economic stagnation. That is because stagnation is the logical next stage of the existing paradigm.
That report became a core chapter in my 2012 book, From Financial Crisis to Stagnation, the blurb for which reads:
The U.S. economy today is confronted with the prospect of extended stagnation. This book explores why. . . . Financial deregulation and the house price bubble kept the economy going by making ever more credit available. As the economy cannibalized itself by undercutting income distribution and accumulating debt, it needed larger speculative bubbles to grow. That process ended when the housing bubble burst. The earlier post-World War II economic model based on rising middle-class incomes has been dismantled, while the new neoliberal model has imploded. Absent a change of policy paradigm, the logical next step is stagnation. The political challenge we face now is how to achieve paradigm change.
The big analytical difference between Foster and Magdoff and myself is that they see stagnation as inherent to capitalism whereas I see it as the product of neoliberal economic policy. Foster and Magdoff partake of the Baran-Sweezy tradition that recommends deeper socialist transformation. I use a structural Keynesian framework that recommends reconstructing the income and demand generation mechanism via policies that include rebuilding worker bargaining power, reforming globalization, and reining in corporations and financial markets.
Larry Summers’ story of serial bubbles delaying stagnation has substantial similarities with both accounts but he avoids blaming either capitalism or neoliberalism. That is hardly surprising as Summers has been a chief architect of the neoliberal system and remains committed to it, though he now wants to soften its impact. Instead, he appeals to the black box of “secular stagnation” as ultimate cause and suggests fiscal policies that would ameliorate the demand shortage problem. However, those policies would not remedy the root cause of stagnation as they leave the economic architecture unchanged.
Though Summers and Krugman are relative late-comers to the stagnation hypothesis, they have still done a great public service by drawing attention to it. Now that stagnation has been identified, the real debate can begin.
The questions are what caused stagnation and what must be done to restore shared prosperity. There is no guarantee we will answer those questions correctly (my prior is mainstream economists will continue their track record of getting it wrong). But it is absolutely certain we will not get the right answer if we do not ask the right question. So thank you Larry Summers and Paul Krugman for putting stagnation on the table. Let the debate begin.
Thomas I. Palley is Senior Economic Policy Adviser for the AFL-CIO and Research Associate at the Economic Policy Institute. Among his publications in recent years is From Financial Crisis to Stagnation: The Destruction of Shared Prosperity and the Role of Economics (Cambridge University Press, 2012). This article was first published in his blog thomaspalley.com on 24 February 2014; it is reproduced here for non-profit educational purposes.