Scott Sumner  

What kind of Great Stagnation?

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Paul Krugman likes to mock extremely talented conservative economists every time they make a statement that seems inconsistent with the textbook AS/AD model of demand shock-created recessions. And yet as far as I can tell, the views of people like Krugman and Larry Summers are just as heterodox as those of Lucas, Barro, Cochrane, Fama, etc. Krugman and Summers seem to think the world is stuck in a long-run period of stagnation that has demand-side causes.

Over at TheMoneyIllusion I recently did a post suggesting that there really was a Great Stagnation. I claimed that this could explain two facts. One is the very low 30-year bond yields in developed countries. And second, the fact that real GDP growth in the US has been very slow (about 2%) during a period of rapidly falling unemployment rates. But I had in mind the sort of supply-side stagnation that Tyler Cowen hypothesized, not a problem that could be fixed with more nominal spending (although I also think that's been a problem in recent years.)

It seems to me that the Krugman/Summers view has three big problems:

1. The standard textbook model says demand shocks have cyclical effects, and that after wages and prices adjust the economy self-corrects back to the natural rate after a few years. Even if it takes 10 years, it would not explain the longer-term stagnation that they believe is occurring.

2. Krugman might respond to the first point by saying we should dump the new Keynesian model and go back to the old Keynesian unemployment equilibrium model. But even that won't work, as the old Keynesian model used unemployment as the mechanism for the transmission of demand shocks to low output. If you showed Keynes the US unemployment data since 2009, with the unemployment rate dropping from 10% to 6.1%, he would have assumed that we had had fast growth. If you then told him RGDP growth had averaged just over 2%, he would have had no explanation. That's a supply-side problem. And it's even worse in Britain, where job growth has been stronger than in the US, and RGDP growth has been weaker. The eurozone also suffers from this problem.

The truth is that we have three problems:

1. A demand-side (unemployment) problem that was severe in 2009, and (in the US) has been gradually improving since.

2. Slow growth in the working-age population.

3. Supply-side problems ranging from increasing worker disability to slower productivity growth

Only the last two can explain the slowing long run trend rate of RGDP growth, as well as the low real interest rates on 30 year T-bonds.

I mentioned that there was a third problem with the Krugman/Summers view. They favor big government Keynesian demand-side remedies for what they see as a sort of permanent liquidity trap. This fits with the newly fashionable anti-neoliberal views on the left. Thomas Piketty's new book made the wildly implausible claim that neoliberal reforms had not helped countries like Britain. However the countries least likely to be mentioned in discussion of "The Great Stagnation" are precisely those countries that have pretty good supply-side fundamentals, and/or relatively small government. Here's the Heritage Foundation's list of the top 10 countries for Economic Freedom:

Screen Shot 2014-09-26 at 1.21.23 PM.png
Now I don't want to oversell this list. Many of the top 6 countries have fast population growth. It's hard for any country to completely overcome the slowdown in the rate of global productivity growth. But I think any fair observer would note that (with the exception of Ireland) the "usual suspects" in the stagnation discussion (Japan, the US, Britain, the 18 eurozone members, etc) are conspicuously missing from that list. And while Ireland undoubtedly was hammered by a big demand shock, their RGDP rose 7.7% over the past 12 months, a rate the US could only dream about. So while the top ten countries are not perfect (Denmark's performance has been mediocre) they've clearly done better than most developed countries. That doesn't provide much support for the progressives' claim that the eurozone is doing really poorly because while they have the biggest governments on Earth, their governments need to be even bigger to overcome the Great Stagnation.

[The Fraser Institute top 10 list replaces Chile, Ireland and Denmark with the UAE, Bahrain and Finland.]

Also note that the eurozone country that is usually seen as doing best (Germany), greatly liberalized its labor markets in 2003-04. Back in 2007, before any of these problems developed, I did a study of neoliberal reforms in developed countries. I looked at all 32 countries with per capita incomes above $20,000. Guess which one had the least neoliberal economy? (Hint: It was doing well at the time of my study, which puzzled me.)

The answer is Greece.

PS. Below I list everything I know about Mauritius:

It's in the Indian Ocean.

Comments and Sharing

COMMENTS (25 to date)
ChrisH writes:

Mauritius has a French creole, spoken by ethnic South Indians.

And, it was the home of the Dodo.

ThomasH writes:

It seems quite possible that slow growth in working age population is at least partly due to low grow in demand for labor. And slow growth in productivity is by definition slow growth in output divided by not much slower growth in the labor force.

After the last big downturn 1929-32, real gdp grew rapidly until derailed by austerity in 1939.

If the Fed had kept ngdp growing at 5-6% (and never let anyone doubt that it would fail to do so) and we had 4-5% inflation, then we could be pretty sure we have supply-side problems. With the Fed policies we've had (and with inflation hawks dominating the financial press an passing for "economists" and Republicans crying out against "printing money" who can blame them too much) and the failure of governments to start investing in projects with positive NPVs at near zero interest rates, it is hard to reject the hypothesis that growth of demand has been slack.

Hence, it's hard to know if we are in a "great stagnation" or in a "great monetary-fiscal screw up."

Edogg writes:

From looking at this,

Now look forward. The Census projects that the population aged 18 to 64 will grow at an annual rate of only 0.2 percent between 2015 and 2025. Unless labor force participation not only stops declining but starts rising rapidly again, this means a slower-growth economy, and thanks to the accelerator effect, lower investment demand.

By the way, in a Samuelson consumption-loan model, the natural rate of interest equals the rate of population growth. Reality is a lot more complicated than that, but I don’t think it’s foolish to guess that the decline in population growth has reduced the natural real rate of interest by something like an equal amount (and to note that Japan’s shrinking working-age population is probably a major factor in its secular stagnation.)

There may be other factors – a Bob Gordonesque decline in innovation, etc.. The point is that it’s not hard to think of reasons why the liquidity trap could be a lot more persistent than anyone currently wants to admit.

Doesn't this agree with what you think is going on?

And about demand shocks having cyclical effects, could the Fed sustain poor demand and high unemployment if it wanted to? Consistently steer the economy towards low NGDP growth and high unemployment?

Scott Sumner writes:

Chris, Thanks, you've tripled my knowledge of Mauritius.

Thomas, I'm afraid there are lots of mistakes. The relapse was in 1937, not 1939, and it certainly was not caused by "austerity." It was caused by tight money and higher labor costs.

The demand for labor has no role in the growth of the working age population, which is determined by decisions made by women 2 decades earlier.

The recent slow growth was not caused by a fiscal policy screw-up; growth accelerated when austerity kicked in during 2013. Monetary policy played a role in the recession, but there is also a very poor supply-side performance.

Edogg, Krugman believes in many of the same things as I do, but he also believes lots of things that I don't. One of those false beliefs is that deficient demand helps explain the secular stagnation. It doesn't, at least not in any significant way.

You asked:

"And about demand shocks having cyclical effects, could the Fed sustain poor demand and high unemployment if it wanted to?",

Yes, it might be able to. Of course it is actually doing the opposite, steering toward a sharp fall in the unemployment rate.

E. Harding writes:

Mauritius is roughly two-thirds Indian, one-quarter Black, had one of the biggest improvements in the world in the economic complexity of its exports between 1960 and today [see the Atlas of Economic Complexity], and was doing pretty well during the era of British rule (see Structural Impediments to African Growth? New Evidence from Real Wages in British Africa, 1880–1965). It seems to have a strong banking sector. Its PISA scores are much better than those in India.

Todd Kreider writes:

When you put up the Top Ten list I rolled my eyes. But then I saw that you didn't want to "overplay it" -- I'd say that you don't want to even go there.

ThomasH writes:


Not being an idiot (I hope) I accept your corrections without being fully convinced that without rapidly expanding demand, we cannot know just how much if any supply side stagnation we have. And the costs of discovering that higher demand only gets us 4-5% inflation vs the costs of not getting that possible real growth seems so small as to be well worth the risk.

A question about the Depression recession (wasn't it 38?). Three was a big tax increase and lower deficit back there sometime (you know and I'd have to look it up). Did they have nothing to do with the monetary tightening? But anyway (my argument is not about the fiscal/monetary mix in creating or not creating demand), the fact that there was strong growth after '31 looks like demand pulling unemployed resources back into production. We have not had that in 2009-2014.

And the federal government did invest in a lot of long-life capital goods. You can still use trails in National parks cut by the CCC and electricity produced by TVA and the Hoover Dam.

I must have misspoken. I was wondering if a lot of decline in the LF participation -- "retirement" and "disability" is not due to people having difficulty in finding jobs. A "stagnation" with fast growth per participating worker would not be "stagnant" in my book.

Mike writes:

Having Mauritius on this list amazes me and then leads me to question the whole thing. (The list, not your analysis.)

I spent nine months in Mauritius and me and my company where shaken down by high government officials more than once.

Having said that, it was a delightful place.

E. Harding: Mauritius does have a fairly well educated population and a fairly low wage structure. Lately exchange rates and lower cost countries are having an impact on the textiles, which in the past were a big item on their exports. (When you order a suit from Gieves and Hawkes at No. 1 Savile Row, London, it will be made in Mauritius).

Sugar, and the associated Rum and Cane liquor, probably are the largest exports now.

Descendants of the French colonists still control much of the land in Mauritius and most of the sugar cane land.

Most of the white people (about 2% of the population) speak French with each other.

The banking sector handles "black" money from India. This is why the tiny nation of Mauritius is the leading foreign investor in India.

There are no good restaurants in Mauritius.

There is a small Chinese population (about 3%).

The beaches are wonderful. The fishing can be very good. The island is safe. If it weren't so darn far away (It was 30 hours of travel time from Dallas), I would go back.

Scott Sumner writes:

Thanks E Harding.

Todd, Thanks for the impressively detailed, point by point rebuttal.

Thomas, The recession began in 1937 and ended in 1938. One fiscal action may have played a small role---the 2% payroll tax, which increased labor costs. But there were two far bigger factors. A major union drive sharply increased wages, and then a tight money policy led to a 9% fall in the WPI. The combined effect was much higher real wages in the late 1937, and falling employment.

I agree that early retirement and disability has played a role. Those are a mix of supply and demand side. But in recent years employment has risen briskly, and growth is still slow. So they are not the key factor in the long term stagnation.

Scott Sumner writes:

Mike, Obviously I am in no position to contradict you. But one word of caution. Corruption is only one of ten factors on the list. For instance, many are surprised to see Denmark at number 10 on the list. It has arguably the highest taxes and spending in the developed world. But in the other 8 categories it is the most free market economy on Earth. So a country can have one poor rating, and still score high. What are taxes and tariffs like in Mauritius?

T writes:

Scott -- You gotta look at the emp/pop ratio, not the unemployment rate. Wages would be rising if the labor market were tightening.

Mike writes:

Income taxes, after a somewhat generous exemption, are a flat 15%.

Tariffs on imported goods are, from an American standpoint, ridiculous. Tariffs approached 100% on most consumer goods. There were exemptions for production machinery (tractors and such used in the cane fields), there were duty free zones, etc.

As an outsider making well above the mean income for the country, I could observe how hard the tariffs hit the working poor. They would ride tiny engined motorcycles to and from work, getting run off the road by cars, trucks and buses. Tariffs on vehicles were set by engine size, there was huge jump in the rate for going over 50cc in engine size.

The former finance minister behind the tax structure is Rama Sithanen. I was fortunate to have lunch with him one day. He is a very dynamic individual.

I also sense that what might be measured as economic freedom by Heritage, would strike the typical American observing Mauritius as anything but. It is a small population and everybody is known to, or related to, someone in authority. It is a country full of busybodies, there is always someone sticking their nose in your business.

I'll readily admit that my experience is colored by difficulties encountered with coworkers and management. The whole nine months turned out to be one of those unwanted life lessons.

But, hey! The U.S. Government is doing awesome work in Mauritius.

E. Harding writes:

Mauritius's biggest exports are still textiles:
It used to be all based on sugar and rum back in the 1960s.
As for corruption in Mauritius: the relevant Enterprise Survey says that half of firms (extraordinary figure) see corruption as a major constraint there, but only 3.9% of firms ever received a bribe request. The same pattern is found in Niger and Brazil: low bribery incidence, but an extraordinary amount of complaints about corruption.
I wonder why this is. Mike, can you explain this pattern?

Mike writes:

E. Harding:

My experience is limited to Mauritius, but I would posit that the small size of the population works both ways. The government officials know what is going on and stick their nose in "your" business. "You" know them too and are able to effectively use shaming as a defense against bribe solicitations.

Culturally, the Mauritians seemed to be much more actively following political intrigue than most Americans. Maybe it has to do with the fact that in a nation of 1.2 million you have every political office from dog catcher to prime minister on the island. The average Mauritian is much closer to the government than is the average American. In some areas this could be a good thing.

There are about 1.2 million people in the Dallas city limits. The highest level politician around here is the mayor, and this city has a weak mayor / strong manager form of government.

Brian Donohue writes:

Great post Scott.

In the comments, you refer to "2013 austerity".

From where I stand, it looks more like a whiff of sanity.

Last year, Krugman and his ilk were raising the alarum about the plunging deficit, which fell from a trillion to $600 billion.

A year later, and it's $550 billion. How many years into the recovery are we? Austerity, pfft.

E. Harding writes:

@Brian Donohue
-Most of this is due to tax cuts, not spending increases. Were we to have the same tax code as existed in the Year 2000, we would be having a surplus now.

Scott Sumner writes:

T, Tight labor markets don't determine nominal wages, NGDP growth does. But I do agree there is some slack in the labor market, just much less than in 2009 when unemployment was 10%.

Thanks Mike. Yes, it is very hard to compare small and large countries.

Brian, I usually try to put "austerity" in scare quotes, for the reason you mentioned. But there were tax increases and spending cuts in 2013, and the Keynesians did wrongly predict it would slow growth in 2013. Krugman even said it was a test of market monetarism. I agree. :)

Brian Donohue writes:

@E. Harding,

Incorrect. Here's spending:

Compared to 2000, federal taxes are higher on the rich and lower on everyone else. Krugman definitely approves.

E. Harding writes:

I didn't say "tax cuts on the rich". I said "tax cuts".

Brian Donohue writes:

@E. Harding,

But you said most of this was due to tax cuts, not spending increases. I sent you a link that showed government spending as a % of GDP increased from 31.6% in 2000 to 36.2% in 2014. That's something like $750 billion in increased spending per year versus holding the line at 2000 levels.

As far as taxes, then, are you calling for higher taxes on the middle class?

Hazel Meade writes:

I wonder if reduced worker productivity could be a cause. A lot of higher-productivity baby boomers leaving the workforce, and being replced by lower-productivity millenials. Low productivity just because they are at the start of their careers and thus havn't got the training to fill the shoes of all the retiring boomers.

Maybe this is what is bringing down the worker productivity numbers.

Gordon writes:

From my experiences as a long time white collar worker in the American workplace, the changes that I've seen may explain why worker productivity is no longer growing as quickly as it once did. First, there is quite a bit of shuffling of executives between companies. The problem is that many of the managers below that executive will follow that executive from company to company. Therefor, an organization can see a wholesale change in management in which the new managers know very little about the organization, its processes, and its history. And this leads to very poor decision making on the part of the new management.

The second problem is that while company executives may understand the rationale of comparative advantages and opportunity costs when dealing with other companies, this logic is forgotten when dealing with employees. The typical white collar worker these days must handle many of the tasks that used to be handled by specialists dedicated to those tasks. For example, engineers must spend time learning how to use project management and requisition systems rather than doing engineering work because the people that used to be dedicated to these activities no longer exist. And going back to the issue I raised in the previous paragraph, many individuals must handle tasks that their managers had previously handled.

Mark Rogo writes:

I'm confused about something. While I'm not a huge fan of the government these days, I'm a pretty big fan of its track record at building infrastructure that has paid a productivity dividend for decades to come. It gave us the interstates, the TVA, et al.

Is it completely crazy to believe that putting people to work on a long-distance electrical grid, a nationwide fiber-optic network, selected rail projects, airport improvements, deficient bridge repair wouldn't pay similar dividends?

In many cases the gov't would merely be financier and ultimately lessor of infrastructure that would be used by private enterprise. In some, it's the "last resort" builder (see bridges). But in all cases people wind up working, they build something lasting, and interest costs on this are currently near nil.

Oh, and yes, they pay taxes on their wages.

myb6 writes:

Wouldn't low long-term rates and somewhat slower RGDP growth also be explained by growth of the capital stock?

Has TFP also suddenly slowed? That would be evidence against the capital stock theory, particularly if the TFP calculation adjusted for changes in labor quality.

asherdresner_ writes:


Thanks for this post. As a non-economist, I learn a lot from blogs like this.

When you write

"A demand-side (unemployment) problem that was severe in 2009, and (in the US) has been gradually improving since"

it sounds like you have a reason to dismiss hypotheses for low demand other than unemployment. Is that right?

For example, the Stiglitz/Robert Gordon argument that one of the reasons for secular stagnation is low income growth for most US households over the last few decades - eg p.51 at . And I'm sure you're familiar with this: - which seems to mean less disposable income than there would have been in the decades following world war two.

If I've understood your position right, I'd love to get your take on why you only look at unemployment when considering demand-side causes of long-term lower growth rates.



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