Bewitched, becalmed, bewildered
In the first decade of the 21st century Western economic growth entered the doldrums. The question was why. Former Harvard president Larry Summers noticed that something changed after the 2008 financial meltdown. The economic spring which had always bounced back had lost its elasticity. He diagnosed it as secular stagnation.
As surprising as the recent financial crisis and recession were, the behavior of the world’s industrialized economies and financial markets during the recovery has been even more so.
Most observers expected the unusually deep recession to be followed by an unusually rapid recovery .... Had the American economy performed as the Congressional Budget Office forecast in August 2009—after the stimulus had been passed and the recovery had started—U.S. GDP today would be about $1.3 trillion higher than it is.
Almost no one in 2009 imagined that U.S. interest rates would stay near zero for six years, that key interest rates in Europe would turn negative, and that central banks in the G-7 would collectively expand their balance sheets by more than $5 trillion. Had economists been told such monetary policies lay ahead, moreover, they would have confidently predicted that inflation would become a serious problem—and would have been shocked to find out that across the United States, Europe, and Japan, it has generally remained well below two percent.
The existence of this beast had been mooted for some time. But many economists doubted the animal actually existed. Paul Krugman, whose solution to low growth is government spending was disturbed by Summers thesis that stimulus spending was not working this time. Krugman wrote "the radical part of Larry’s presentation [is] his suggestion that this may not be a temporary state of affairs." To a man who believed that economies could be stimulated by burying money in coal mines or defending against fake invasions by space aliens this was a shattering possibility.
This is the kind of environment in which Keynes’s hypothetical policy of burying currency in coalmines and letting the private sector dig it up – or my version, which involves faking a threat from nonexistent space aliens – becomes a good thing; spending is good, and while productive spending is best, unproductive spending is still better than nothing....
[But] Larry explicitly invokes the notion of secular stagnation, associated in particular with Alvin Hansen ... Think of it this way: during the period 1960-85, when the U.S. economy seemed able to achieve full employment without bubbles, our labor force grew an average 2.1 percent annually. In part this reflected the maturing of the baby boomers, in part the move of women into the labor force. ...
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. ...
Back in the day, Hansen stressed demographic factors: he thought slowing population growth would mean low investment demand. Then came the baby boom. But this time around the slowdown is here, and looks real.