...against fictions and other tall tales

Monday, 27 October 2014

Secular stagnation, secular exhilaration and fiscal policy

Paul Krugman is right: secular stagnation has historically always referred to a situation of persistent low demand, which, according to my old 1971 Samuelson and Scott textbook, renders it inappropriate for governments to attempt to balance the budget over the business cycle (as per the principle of countercyclical compensation).

While in a secular stagnation (Is the shorthand 'SecStag' catching on?), Samuelson and Scott suggest that constant or near-constant government budget deficits are needed to sustain an adequate level of demand to achieve full employment, as shown here:

Samuelson and Scott (1971:437)

The policy stance required during secular stagnation contrasts with the stance needed during periods of so-called "secular exhilaration" (with high demand), during which the right policy is running budget surpluses as a way to avoid overheating the economy and reduce inflationary pressures.

It's true that sustained deficits will increase public debt; however, the low cost of borrowing that usually comes with secular stagnation should help to ensure public debt levels won't get out of hand.

But hasn't the experience of Japan in the 1990s taught us that big deficits don't work to stimulate a stagnant economy, you might ask?

The answer is no. Kenneth Kuttner and Adam Posen demonstrated in "Passive Savers and Policy Effectiveness in Japan" that low tax revenues caused by a weak economy were to blame for the rising debt levels, not expansionary fiscal policy.

Of course, it's important that the spending be directed toward productive use.

I can think of two ways to achieve this goal. First, governments should invest in early childhood learning, an investment that's well known to pay-off in the long-run. Second, investing in infrastructure is also a good bet, as demonstrated several years ago by David Aschauer and Alicia Munnell, and as recently recommended by the IMF.


Aschauer, D., 1989, "Is Public Expenditure Productive", Journal of Monetary Economics, Vol. 23, pp. 177-200.

IMF, "Is it time for an infrastructure push? The macroeconomic effects of public investments", Chapter 3, October 2014.

Kuttner, K. and A. Posen, "Passive Savers and Policy Effectiveness in Japan", Institute for International Economics, 2001.

Munnell, A., 1990, "Why has productivity declined? Productivity and Public Investment" New England Economic Review, Federal Reserve Bank of Boston, January/February issue, pp. 3-22.

Samuelson and Scott, Economics, 3rd Canadian Edition, McGraw-Hill, 1971.


  1. “It's true that sustained deficits will increase public debt..”. Excuse me, but presumably you’ve heard of QE? That involves having the state print money and buy up the state’s debt. The net result is that deficits do not increase the debt: they simply increase the amount of base money.

    Indeed Keynes said that deficits can be funded either with borrowed money or printed money. In fact several economists advocate cutting out the entire charade of public debt and simply having the state print money and spend it (and/ or cut taxes) when stimulus is needed.

    Re your last paragraph, why go for investment? Obviously if a particular type of investment pays for itself it should go ahead. But that has NOTHING WHATEVER to do with government happens to be running a deficit. I.e. as far as stimulus goes (which the purpose of deficits) $X of investment spending has much the same effect as $X of CURRENT spending.

    1. Thanks for the comment, Ralph. I agree with your first two paragraphs, I've discussed the possibility of printing money (as an alternative to issuing bonds) in an earlier post. It's good that you mentioned it. As for the third paragraph, I agree any type of spending will work but I think spending on productivity-enhancing investments are the way to go.

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