Home Economic Trends How to Avoid Secular Stagnation – Frank Shostak (01/24/2020)

How to Avoid Secular Stagnation – Frank Shostak (01/24/2020)

In his January 10 interview on Bloomberg TV, former US Treasury secretary Larry Summers expressed concern that despite the aggressive lowering of interest rates by major central banks, economic activity does not appear to be responding.

Summers suggested that something is not quite right. He is of the view that the Alvin Hansen’s secular stagnation theory might explain the present economic climate.

Hansen introduced his theory in the 1930s to provide an explanation for the Great Depression. Hansen’s explanation of the Great Depression of the 1930s was that the US had become mired in permanent stagnation from which it could not be lifted by free market capitalism. In his presidential address to the American Economic Association in 1938, Hansen asserted that the US was a mature economy that was stuck in a setup that it could not escape from. According to Hansen technological innovations had come to an end and population growth was stagnating. Hence, investment opportunities would be scarce, and there would be nothing ahead except secular economic stagnation.

As a result of insufficient aggregate demand, this theory holds, the private sector of the economy is likely to remain in a permanent stagnation over a prolonged period unless fiscal policy is implemented to boost investment via public works projects. In this way of thinking, demand is the key to economic growth, and there is the urgent need to start boosting the inadequate aggregate demand by increasing government outlays on capital investments. This, it is held, could lift the economy out of the permanently stagnant configuration.

Since individuals are goal seeking, they are constantly striving to achieve as many goals as possible. What limits their ability to achieve various goals are means. Means have to be generated in order to serve in the achievement of various goals or ends.

For instance, an individual who sets a goal of building a house would have to organize the necessary materials and tools for this. These materials and tools would have to be produced, i.e., there is the requirement of having a suitable infrastructure to generate all the materials and tools.

This goal also implies that various individuals who are engaged in the making and the enhancement of the infrastructure must be supported in terms of various goods that are required to support their lives and well-being.

The goods that are provided to them in exchange for doing this do not emerge out of the blue. Those individuals who are producing final goods must allocate a portion of their final product to various individuals who are engaged in the enhancement and the expansion of the infrastructure.

The final goods that are provided to them are real savings. (The producers of final goods, rather than consuming them entirely, may decide to channel (invest) them to individuals who are expanding and enhancing the infrastructure.)

For both Hansen and Summers, savings is considered bad news since it is regarded as undermining the aggregate demand.

What commentators such as Summers are saying is that the underlying fundaments of the economy are not in a good shape. However, they are blaming the wrong causes for the underlying economic weakness. For them, weak population growth is an important factor because it undermines aggregate demand and hence economic growth. Unfortunately, none of the commentators emphasize that at the heart of economic growth is the pool of real savings. Given that savings are seen as bad for the economy, one is not surprised that Summers advocates for the strengthening of fiscal and monetary policy, which he believes will place the economy on a trajectory of strong economic growth.

But all that these loose policies are going to do is set in motion a further diversion of real savings from wealth generating activities to non-wealth generating activities. This is likely to undermine the pool of real savings and will definitely set the foundations for prolonged stagnation.

Also, both supply and demand must work in harmony. In a market economy, the purpose of production is consumption. People produce and exchange goods and services with each other in order to promote their lives and well-being — their ultimate purpose. This means that consumption cannot arise without production, while production without consumption would be meaningless.

In a market economy, both consumption and production are in harmony with each other, and consumption is fully backed by production.

In order to remove the threat of secular stagnation what is required is to shrink government outlays and to close all the loopholes for the creation of money out of thin air.

Contrary to the assertions of Hansen and various Keynesian commentators, wealth can only be generated by wealth producers, and not by government and central bank bureaucrats.

Frank Shostak‘s consulting firm, Applied Austrian School Economics, provides in-depth assessments of financial markets and global economies.