Home > Global Imbalances, Growth, Inequality > Reduce Inequality to Fight Secular Stagnation

Reduce Inequality to Fight Secular Stagnation

December 22, 2013 Leave a comment Go to comments

Larry Summers’ IMF speech on secular stagnation partially shifted the attention from the crisis to the long run challenges facing advanced economies. I like to think of Summers’ point of as a conjectures that “in the long run we are all Keynesians”, as we face a permanent shortage of demand that may lead to a new normal made of hard choices between an unstable, debt-driven growth, and a quasi-depressed economy. A number of factors, from aging and demographics to slowing technical progress, may support the conjecture that globally we may be facing permanently higher levels of savings and lower levels of investment, leading to negative natural rates of interest. Surprisingly, another factor that had a major impact in the long-run compression of aggregate demand has been so far neglected: the steep and widespread increase of inequality. Reversing the trend towards increasing inequality would then become a crucial element in trying to escape secular stagnation.

The generalized increase of inequality that began in the early 1980s is well documented. Redistribution took different forms, but in all cases benefited mainly the rich and the very rich (the top one percent of the population). Inequality in turn, interacting with institutional differences, may go a long way in explaining the accumulation of global imbalances that are a side effect of secular stagnation: Excess demand and trade deficits in the US and in other countries (most notably peripheral Eurozone countries), financed by excess savings from other regions of the world. The transfer of resources from low to high propensity-to-save individuals, resulted in a reduction in the average propensity to consume, and increased aggregate savings, with two major, related effects: first a large mass of liquidity that with the help of low interest rates fuelled a series of speculative bubbles and misallocation of savings. The second effect is a chronic deficiency of aggregate demand, which would then permanently lower the growth rate of the economy. Therefore, inequality and the ensuing lower propensity to consume, contributed to the drift towards secular stagnation described by Larry Summers.

Inequality therefore may have contributed, along with demographics and slowing innovation, to the slow drifting of the global economy towards secular stagnation. But how could inequality, and the resulting compression of aggregate demand, lead in some areas to excess savings, and in others to excess debt? The answer to this apparent paradox lies in different institutional settings and policy responses.  Starting from the mid-1990s in the US private borrowing surged, thanks to a weakly regulated financial system, and to the belief that some sectors (financial, real estate) would grow indefinitely. Consequently, consumption and investment remained high, even if financed through debt and bubbles. In most of Europe (the exception being Spain and the United Kingdom) stricter regulation and tighter monetary policies made borrowing more difficult while fiscal policies were constrained by the treaties. This led the second largest economic block of the world to rely on export-led growth. Thus, US demand was financed by savings from the EU (but also from East Asia, and oil producing countries), and in turn lifted these areas’ growth with its imports. This delicate balance was sooner or later doomed to break.

If Summers’ conjecture is right, the pattern we observed leading to the crisis is bound to be repeated in the future, as different areas of the world will react differently to the trend towards secular stagnation. A durable rebalancing of the global economy can only happen if we manage to escape the chronically depressed aggregate demand that according to Summers has become the new normal.

In the current situation income distribution may turn out to be the easiest lever to pull in order to fight secular stagnation. Demographic factors, or innovation trends, are hard to govern and to orient. A reduction of inequality can instead be obtained by acting on multiple levels, starting with the return to more progressive tax systems. Furthermore, the social insurance role of the government should be revamped. Last, but not least, a renewed focus on the provision of public goods, particularly intangible ones such as education and health is desirable.  At the European level, we should aim to real coordination of tax policies, so as to avoid tax competition and social dumping, which benefit high incomes and capital. Taken together, these measures would reduce income and consumption inequality, thereby stabilizing the economic cycle and reducing aggregate savings. This would allow for growth rates that may be less remarkable than in the past, but certainly more sustainable and equitable.

  1. Bill Kelly
    December 22, 2013 at 4:16 pm

    This is a very good post. I have been reading your log for several months now,and appreciate your sharing your wisdom. Bill Kelly

    Sent from my iPad3



  2. varun pratap singh
    December 23, 2013 at 2:03 pm

    nice post!


  3. December 27, 2013 at 12:20 am

    Cannot speak about Euro issues, but here’s my thoughts on secular stagnation in the US http://tinyurl.com/ka55jk5

    I think Europe is probably in much worse shape than the US, since the demand for Euros has not been satisfied. So in addition to all the secular trends such as the inequality, aging of the population and the national debt of the member countries, you have the deflationary influence of euro shortage prompted by massive allocation into cash, which has taken place in Europe over the last several years.


  4. January 1, 2014 at 10:24 am

    The social equality is the representation of the values ​​of a culture. At present, the dominant culture is linked to interest rates and finance. The vision of those who practice this culture is very short-term means to earn more money in a few seconds and of little interest to them a slower process, as in the case of public investment for the school and the education of citizens. Equality is always linked to the raising of the general culture, by which you change the shape new values ​​and above all we fight populism.


  5. Mnoro
    May 8, 2014 at 3:40 am

    Hi, I am a master student in economics and have become interested in the topics of heterogeneity in macroeconomics, more specifically in inequality in consumption and would like to study more in this area. I would highly appreciate it if you help me in this regard with introducing me the relevant articles. Could you please advise me if there are any studies done on the drivers of inequality growth and how to solve it. Thanks in advance.


  6. Karl Bonner
    May 27, 2014 at 8:16 am

    Nice! I found someone else out there who sees a connection between inequality and propensity to save – and thus providing an “underconsumptionist” explanation for secular stagnation.

    This theory also suggests that in countries like the United States, a large minimum wage increase (to at least $12/hour, and preferably $15) ought to generate quite a bit of extra aggregate demand, since it would hit a pretty large chunk of the workforce and put purchasing power into the hands of people with a very high marginal propensity to consume. We should allow several years of phasing in for smaller employers, though…


  1. March 19, 2014 at 12:42 pm
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