BusinessThink: What is secular stagnation?

Richard Holden: It’s a much-talked-about concept. So, there have been two views of macroeconomics – a more liberal, Keynesian view and a more conservative, rational expectations or Chicago/Minnesota-style view. But both of those views of macroeconomics say it’s all about fluctuations around some average rate of economic growth – and, how do we smooth out the fluctuations? 

Secular stagnation – an idea that goes back to Alvin Hansen, who was a Harvard economics professor in the 1930s – was what happens if the average is much lower than we thought about. And in the wake of the recovery, or lack of recovery, from the financial crisis of 2008 that idea was re-popularised by former US Treasury secretary and Harvard economics professor Larry Summers.

BusinessThink: But Hansen was living in completely different economic times. After all, it was nearly a century ago. Are his theories from then still relevant now?

Holden: Well, it’s maybe that they were a few generations ahead of their time. But the basic idea that growth is much lower than what we’ve thought about seems very relevant. So we’ve been used to thinking that good economic growth in a country like the US or Australia or the UK is sort of 3%, or maybe a little higher, something like that. You now see the IMF saying forecasts for Australia are more like 1.7% or 1.8%; [and] the Reserve Bank downgrading forecasts.

And so the idea that we might be in a permanently lower secular lower growth environment seems like it’s got a lot of truth to it.

BusinessThink: Then are we doomed? Is this going to carry on for the next decade or two?

Holden: Well, the forces that are pushing on it seem like they are going to carry on. So the basic sort of underlying driver of this is you have an enormous amount of global savings chasing relatively few productive investment opportunities, at least in dollar terms. So the way I like to think about it is this: once upon a time, you had to build big, expensive steel plants and big, expensive railroads. Those were valuable; they cost a lot of financial capital to get done. These days, if you have a really, really good idea, like Mark Zuckerberg did, you can build a company that’s more valuable than in fact the entire top nine ASX companies in Australia put together.

So you just don’t need as much money. That took kind of $1000 and a good idea – it’s a very good idea, but it took a relatively small amount of financial capital. So you need less money, and that’s led to the sort of equilibrium interest rate, as economists call it, being much lower, and what you see with that is very, very low interest rates, very, very low inflation, and low growth rates.

BusinessThink: But conventional economic theory (and I’m going back to Adam Smith here) says that if we’ve got the low cost of capital – in other words, low interest rates – then economic growth is going to increase from that because we’ve also got demand that’s obviously there, and low unemployment. In theory, we should be in the middle of the boom times. It just doesn’t seem to be happening.

Holden: Well, that’s exactly right. And that was not only the Adam Smith view of the world; that was the Bill Clinton view of the world. And the idea at that time in the US in the early 90s was we’ve really got to get the cost of capital down. And that’s what led to cutting budget deficits, trying to get interest rates down so that businesses could spend and invest. Now the problem is that there’s a lack of opportunities for them to do that, and the question really is how can we stimulate the economy in a world where interest rates are effectively zero or even negative? And that’s really going to require stimulus on the fiscal side – governments spending more money – than people like me thought was prudent in the past.

BusinessThink: Well, if it’s not prudent – and surely, playing devil’s advocate here – if we’re spending money, taxes are going to go up. And again, conventional economic theory says that’s going to put a handbrake on the future.

Holden: Well, that is the conventional theory. But you have to remember one very important thing has changed, and that is the rate at which governments can borrow money. So the Australian Government can borrow long-term 10, 15, 20 years for 1% these days, or even slightly lower than 1%. And that’s in nominal terms; that’s before adjusting for inflation. So the fact that the government can borrow at a much lower interest rate means that they can in fact borrow a lot more. So it doesn’t necessarily mean raising taxes the way it would have meant in the past, and maybe it means Australia getting more comfortable with the idea that instead of having a debt or a net debt to GDP ratio of 15%-20% as we do now, we might need to be more comfortable with something a little bit higher than that.

BusinessThink: Many people I’m sure may be uncomfortable about that, but at the same point we do have interest rates that look like they’re back in the 1950s. It’s great, but that’s going to drive up asset values surely.

Holden: Well, it will, and it has. One of the real concerns is that people who have capital, and own assets, are going to see the value of those assets increase; people who work for a living and whose wages are not growing are going to be less well-off. And so the concern about what this all does for inequality is very important, and it’s quite a pressing concern.

BusinessThink: It certainly is. But we’ve got to look at the economic future. Or if you have the ear of the Treasurer and you were saying to him there’s a major problem now with secular stagnation, what would you say the policies he should implement would be?

Holden: Well, what I would say is, “Treasurer, you have shown that you can balance the books. You’ve shown that you can get back in the black. Now is not the time to be tightening the government belt. Now is the time to be investing for the future and providing fiscal stimulus the Reserve Bank has been calling for, the private sector has been calling for, that the IMF has been calling for and people like me have been calling for. And it’s really time to get on with stimulating the economy for the long term, not balancing the books in the short term.”

BusinessThink: But that will never fly politically because for the past decade we’ve been told we’ve got to balance the books.

Holden: Well, you know, both sides of politics in Australia have practised or fallen into the trap of what I’ve referred to as balance budget fetishism. I think both sides – and I’ve been equally critical of the Labor Party for this – have been trying to sort of prove their economic bona fides. I think history will judge both sides of politics in the long run as to what they’ve done to deal with changing economic times and changing economic circumstances.