Secular Stagnation

Secular Stagnation Definition

Secular stagnation refers to a situation wherein a normally functioning market economy suffers from extended periods of sluggish or zero growth. It eventually results in a high unemployment rate and increased investment-savings imbalance within a nation. The condition continues to prevail until the government intervenes through aggressive fiscal policy.

An economy begins to weaken due to the lack of investment opportunities resulting from declining population growth and a slower rate of technological change. Consumer debts, low interest rates, and income inequalityIncome InequalityIncome Inequality is defined as an unequal distribution of income between the masses or a situation when a large proportion of total income is held by the small percentage of the population. It happens due to variation in sources of income, number of dependents, easier availability of resources, etc.read more are other factors contributing to slowing consumer demand. In response to this, the private sector and people start saving more and investing less or nothing. It ultimately leads to reduced growth and inflation that soon turns into secular or long-term economic stagnation.

Key Takeaways
  • The term secular stagnation refers to a decline in market demand over time. It eventually results in a consistently slow or no economic growth of a nation.
  • Alvin Hansen first proposed the theory in 1938, predicting the lack of investment opportunities in the United States post-Great Depression due to sluggish economic recovery.
  • The causes of secular stagnation are depreciated productivity growth, enhanced dependency ratio, and investment-savings imbalance.
  • In 2016, American economist Lawrence Summers explained how increased savings rather than investments led to an economic imbalance, income inequality, and low interest rates in the United States consumer market.

How Does Secular Stagnation Work?

The economic growth of a nation responds to the levels of demographic and technological change. In other words, the rate of investment increases or decreases in proportion to consumer demands. But once the birth rate and technological progress start to decline, the investment opportunities begin to shrink.

It creates a panic among investors, and they shift their focus to saving than investing. Consequently, employment growth stops, inflation reduces, income inequality grows, and interest rates lower in the long run. This prolonged decrease in the capital stockCapital StockThe capital stock is the total amount of share capital (including equity capital and preference capital) that has been issued by a company. It is a way of raising funds by the company to meet its various business goals.read more in an economy due to lack of investment demand is known as secular stagnation.

Secular Stagnation Origin and Impact

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For an economy to remain balanced, the savings should equal investments in a nation. It indicates that the money flow from the outside should be equal to the money flow from the inside. However, it is not easy to equate savings and investments in a stagnant economy. Still, keeping the interest rate below zero will maintain this balance.

Economists Perspectives

American economist Alvin Hansen first proposed the secular stagnation theory during the American Economic Association Presidential Address in 1938. He argued about the consequences of economic maturity and the expected slowdown of the American economy after the Great Depression in the early 1930s.

Based on the sluggish economic recovery post-Great Depression, he predicted depreciating investment opportunities. He counted the closing of the frontier, declining population growth, slowing technological inventions, and the end of immigration as the reasons behind it. Without investment, employment growth and general economic expansion would contract. He proposed that government deficits and rising government debts might ensure economic prosperity.

In 2016, American economist Lawrence Summers explained the theory in the article “The Age of Secular Stagnation: What It Is and What to Do About It,” published in the February 15, 2016 issue of Foreign Affairs. In his article, Summers observed how the increasing desire of businesses and individuals to save rather than invest has been creating an economic imbalance in the U.S. consumer market.

He cautioned that it is widening income inequality and lowering the growth and interest rate. He further suggested the government introduce an expansionary fiscal policyFiscal PolicyFiscal policy is a government policy that is used to control a country's finances and revenue, and it includes various taxes on goods, services, and individuals, i.e., revenue collection. It has an impact on spending levels, so it is referred to as monetary policy's sister policy.read more to overcome secular or long-term stagnation and sustain growth.

Examples

The following examples will explain secular or prolonged stagnation more clearly:

Example #1

Savings is a way of securing the future by accumulating funds to buy necessary items in the long run. As wages received are significant for livelihood, people tend to save more and limit their spending. This limited expenditure reduces the profits earned by companies selling different products and services. It affects the national economy.

When the flow of money into the market gets restricted, it causes inflation. As a result, product prices increase while wages decrease. All this leads to an imbalance between investment and saving.

On the other hand, when a population invests considerably in the market, private firms reap more profits. It generates new job opportunities and higher wage offerings, encouraging significant savings at the same time.

Example #2

Summers considered technological advancements as one of the factors contributing to secular or prolonged stagnation. According to him, the Internet revolution played a significant role in limiting investments.

Internet firms, such as Twitter and WhatsApp, have smaller workforce but share a significant portion of the market. While it increases the financial value of enterprises, technological integration displaces workers and results in fewer job prospects.

American economist Barry Eichengreen opines that cheaper capital goods, such as computer hardware and software, and increased manufacturing efficiency have made firms spend less on buying costly machinery for their operations. This less spending by companies results in stagnating economic growth in the United States and other parts.

Causes

The causes of secular stagnation vary with the economy and other factors. Let us look at some of those:

Causes of secular stagnation

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#1 – Depreciating Productivity Growth

The Financial Crisis of 2008 resulted in the diminishing power of banks to lend and invest. Its impact was so huge that the United States and European Union economy and interest rates fell at unprecedented rates.

Though the market tried to recover, the sluggish economic growth was not enough to maintain the investment-saving balance. This downtrend continues to hit the big economies of the world, causing global secular stagnation.

#2 – Investment-Savings Imbalance

When the economic growth slows down following a recession, it directly affects the employment rates. Factors like job insecurity, uncertain market conditions, social inequality, etc., make the public save more, spend less. Furthermore, lower capital goods prices and a lack of new job creation result in limited investments, which affects the national and global economies. These scenarios create an investment-saving imbalance, which leads to prolonged stagnation.

#3 – Rise In The Dependency Ratio

The rise in the aging population in many developed countries has become more prominent in recent times. As a result, the dependency ratio increases, demanding enhanced tax rates for fulfilling pension and health care requirements. The declining population growth of a nation would lower the potential productivity growth, thereby making the economic recovery sluggish.

Solution To Secular Stagnation

Aggressive fiscal policies and rising government debts are two widely accepted solutions to overcome economic stagnation. In addition to this, decreased business regulations can help sustain economic growth.

Eichengreen, in his article “Secular Stagnation: The Long View,” advocated that the stagnant economic growth of nations around the world, especially the U.S., might accelerate in the future. Though new technologies have disrupted industries, such as healthcare, education, banking and finance, and industrial research, he believes productivity growth is on the cards.

British journalist Martin Wolf criticizes the dependency of the global economy on the central banks for low-interest rates. He also proposes enacting a fiscal policy that allows using government deficits as a cover for private investment.

American journalist David Leonhardt emphasizes finding new solutions to tackle or prolonged stagnation. He cites the 2017 Trump tax law as a perfect example to show how fiscal policy could effectively provide a slight boost to the economy. This conclusion came following the short-term expansion of the American economy to 2.9% in 2018.

Frequently Asked Questions (FAQs)

What is secular stagnation?

Secular stagnation is a condition in which a normally functioning market economy shows negligible or no signs of growth for a prolonged period. Declining population growth and technological change mainly cause this.

What causes secular stagnation?

· Depreciated productivity growth following the Financial CrisisFinancial CrisisThe term "financial crisis" refers to a situation in which the market's key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more of 2008 that affected the United States and European Union economy and interest rates.
· Investment-savings imbalance, when people are willing to save more and invest less in the market to secure their future. As a result, firms reap no profit, no jobs created, and wages decrease.
· The rise in the dependency ratio, demanding enhanced tax rates for fulfilling pension and health care requirements.

What is the impact of secular stagnation?

The secular stagnation might result in a high unemployment rate, income inequality, reduced economic growth and inflation, and increased investment-savings imbalance within a nation.

This has been a guide to What is Secular Stagnation and its Definition. Here we discuss the causes of secular stagnation and how it works, along with solutions and examples. You may also have a look at the following articles to learn more –

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