One question I struggled with in my book was how secular stagnation would manifest itself. Would the unemployment rate stay perniciously high? Or would the symptoms be subtler: a low unemployment rate, for instance, combined with a low participation rate?
The Twitter discussion surrounding the latest US jobs report has reignited my internal debate. So I thought I’d share it. For me the key question is this: what if the declining participation rates, shown in the chart below, are actually a result of secular stagnation? What if the US economy has become incapable of employing as many willing workers as it once could?
This next chart (ht Calculated Risk) focusses only on the 25-54 population bucket, which removes distortions due to education and changing age distribution:
So how can we make sense of these charts? My view is that a structural fall in the growth of the potential workforce has led to fewer investment opportunities, which has driven the ideal interest rate into negative territory. As Larry Summers himself has pointed out, there were signs of stagnation even before the financial crisis. Here’s a repost of the US workforce chart I first introduced in a previous post on secular stagnation.
Notice how the growth in the potential workforce begins to slow in 2000, coinciding with a fall in participation rates. Since then, the only boost in the participation rate occurred during the housing bubble. But what at the time appeared to be sound investments turned out to be toxic and unprofitable, and participation rates have since resumed their downward trend.
The problem, as with most economic theories, is the lack of empirical certainty. Although a lot of evidence supports my view, it is ultimately impossible to say for certain whether the structural decline in workforce growth is the prime culprit. Instead, there could be factors affecting the propensity to save, such as increasing income inequality (the rich save more than the poor) or a rise in corporations’ share of income (corporations save more than workers). In fact, the decline in participation rates might not be down to deficient demand at all — what if a supply side phenomena is at work? Such as a skills mismatch? Or more men becoming stay-at-home dads?
The only entity capable of testing whether the problem stems from demand or supply is the government, by unleashing a deficit spending program designed to boost demand. If participation rates then begin to rise, we can be confident that weak demand was the problem. Contrarily, if the deficit spending triggers inflation (or the central bank is forced to raise interest rates), then the lower participation rates are likely a supply side phenomenon.
The other option is to implement the neutral monetary system proposed in my book. Under neutral money, the central bank has direct control over total demand (although how that demand is allocated will be determined entirely by the free market). By gradually increasing demand, we could test the limits of full employment to the very maximum. Best of all, we could achieve this without relying on debt-fuelled government deficits.