In my last post, I began by discussing the two definitions of secular stagnation — how one relates to the demand-side while the other to the supply-side. As a proponent of a neutral monetary system, I said that I only cared about the demand-side definition, since the main impetus behind neutral money is to solve the problem of deficient spending.
The truth is that the two definitions are inextricably linked. Productivity growth means doing more with less — manufacturing a car, for instance, with eight workers instead of ten. In my book, I suggest that higher productivity growth, which is positive when we view secular stagnation as a purely supply-side phenomenon, could actually exacerbate the problem of demand-driven secular stagnation.
To put it in a more technical way, I hypothesize that productivity growth could lower the ideal interest rate, which is the rate necessary for full employment, further into negative territory. This means that the spending gap — the difference between what we are spending and what we need to spend for full employment — will widen. In other words, the argument long dismissed as Luddite– that advances in technology will cause permanent unemployment — would become valid.
Why might productivity growth drive the ideal interest rate lower? It’s simple: savers tend to save a higher proportion of their incomes the richer they are, while borrowers don’t tend to borrow a higher proportion. For example, an economy that generates $100 in real income at full employment might have savings of $10 and borrowing of $8. This economy would clearly shrink, but not as much as an economy that earns $150 and saves 15% (up from 10%) but still only borrows at an 8% rate. This richer economy saves $22.5 at full employment but only borrows $12. Excess savings at full employment have risen from $2 to $10.5, which translates into a lower employment equilibrium.
In other words, as our real incomes grow, so do our excess savings. And when excess savings grow as a proportion of full employment GDP, production and employment will inevitably shrink.
In an economy free of secular stagnation, the central bank retains the ability to lower interest rates to extinguish these excess savings. This is what Alan Greenspan did in the ‘90s, for instance. Because the tech boom had boosted the rate of productivity growth, Greenspan kept interest rates low for longer than usual to guarantee that the freed-up income would be spent. But with the advent of secular stagnation, this option is no longer available. After years at the zero lower bound, interest rates cannot go any lower. The central bank, in effect, is powerless. In the meantime, productivity growth continues to drive the ideal interest rate lower and lower.
So at heart, there is a paradox of sorts between the two definitions of secular stagnation. If we are suffering from the demand-side version (and I believe we are) we really shouldn’t worry about our supply-side failures. In fact, slower or even negative productivity growth might actually help with unemployment. To paraphrase Keynes: the time for efficiency is the boom, not the bust.
In an ideal world, however, we would adopt a neutral monetary system. Secular stagnation or no secular stagnation, fast productivity growth or slow productivity growth, demand would always be at the level required for full employment.