What Mainstream Economists Get Wrong About Secular Stagnation


The Institute of New Economic Thinking has the article What Mainstream Economists Get Wrong About Secular Stagnation. I came across this because it was reposted in Naked Capitalism under the title Debunking Mainstream Economists on Secular Stagnation and the Loanable Funds Fallacy.

The narrow focus on the ZLB [interest rate Zero Lower Bound] and powerless monetary policy within the framing of a loanable-funds financial system blocks out serious macroeconomic policy debate on how to revive aggregate demand in a sustainable manner. It will keep the U.S. economy on the slow-moving turtle — not because policymakers cannot do anything about it, but we choose to do so. The economic, social and political damage, fully self-inflicted, is going to be of historic proportions.
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Due to our inability to free ourselves from the discredited loanable funds doctrine, we have lost the forest for the trees. We cannot see that the solution to the real problem underlying secular stagnation (a structural shortage of aggregate demand) is by no means difficult: use fiscal policy—a package of spending on infrastructure, green energy systems, public transportation and public services, and progressive income taxation—and raise (median) wages. The stagnation will soon be over, relegating all the scholastic talk about the ZLB to the dustbin of a Christmas past.

My Thoughts

As I was reading the article, I had various reactions to what I was reading.

I think one of the major problems of the theory of supply and demand is that it may be true as a static model (all other things being equal), but the economy (and life) are not static. Unless you can take dynamic effects into account, then this static or even quasi-static model will just not represent what actually happens. This is just another way of saying what this article says. Over time, the supply curve and the demand curve interact. There is hardly, if any, point in time when all other things aren’t changing.

In my world of simulating the behavior of integrated circuits, the problem involves non-linear differential equations, not just non-linear algebraic equations.
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Here is another problem. “… by the national accounts[,] identity of saving and investment (for closed economies),”

Accounting is also a static snapshot of a dynamic system. A bank creates a loan payable in let’s say 30 years. The spending occurs immediately. In accounting terms these two items balance. However, on impact on the economy, they do not balance. Why else would capitalism have noticed the value of buy now, pay later?
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This is no longer a chicken and egg problem of which came first, the chicken or the egg. In real life, there are lots of chickens and lots of eggs. Which came first is irrelevant. Chickens create eggs and eggs create chickens.
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Models are a simplification of reality. They apply best when the things that were simplified away don’t matter much. They fail when the things that were simplified away become important. So, when does the loanable funds model apply?

IMHO, the loanable funds model applies when there is a run on the bank. When the fractional reserve banking system is running smoothly, the loanable funds model is irrelevant. That’s why banks have reserves and monetary systems have central reserve banks. These reserve systems let us ignore loanable funds models.

Final Comment

After reading the whole article, I think most of my points were covered in one way or another.

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