Is Our Economy In The Upside Down?

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Something is strange with the economy.

Normally, in good times, the government seeks to balance its books a bit, borrowing less, paying off some debt or — gasp — maybe even aiming for a budget surplus. And right now, on some important measures, economic times are good. But the government has been increasing spending and cutting taxes — and the budget deficit is projected to grow to nearly $1 trillion, an increase of over 35% since the Tax Cuts and Jobs Act was passed in 2017. Meanwhile, the Federal Reserve would normally be raising interest rates to make sure the price of everything doesn't get out of control. But high inflation is nowhere to be seen, and the Fed is now cutting interest rates.

We're living in the Upside Down. You know, like that shadowy land in Stranger Things, where the laws of physics don't apply and monsters might eat you. It's an alternate dimension where economic textbooks are being thrown out the window. A scary place where despite big deficits and easy money, the economy is slowing down to a rate below historical averages and wage growth remains disappointing. And it's a place where frightening monsters, or demogorgons, continue to scare away investment and productivity. Slaying these monsters is the key to growth and prosperity, but we seem to be stuck in this new world where investment and productivity will not come roaring back. Can we escape?

Stranger Things, Season 1

In 1938, economist Alvin Hansen, then the president of the American Economic Association, gave a speech in Detroit at the organization's annual meeting. It had been almost a decade since a stock market crash had ushered in the Great Depression. The recovery had been puny, and the economy had just dipped into yet another recession. Things were looking bad.

"This is the essence of secular stagnation," Hansen said, "sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment."

Hansen used the term "secular" not in the way normal people use it. He didn't mean nonreligious. He meant the third definition provided by Merriam-Webster: "of or relating to a long term of indefinite duration." And so by "secular stagnation," he meant a long-term period of crappy economic growth.

This Upside Down economy was the product, Hansen said, of a shriveling population, the closing of the frontier and the maturing of industries. The economy had basically grown up. There was nowhere left to go. This situation depressed economic demand and, in particular, demand for investment: factories, machines, houses, cubicles and other stuff (capital) that expands the economy.

He looked spot on for a bit. But then came World War II, which saw an explosion of government spending. And when the war ended, America saw a baby boom, technological innovations and a huge growth in demand for new products, from wood-paneled station wagons to TV dinners to Slinkys. This booming economy fed higher investment and productivity and wage growth, and America transported back to the pretty world of standard economic theory. The postwar years proved to be far from stagnant, and the idea of secular stagnation was thrown in a newly patented trash compactor.

Stranger Things, Season 2

Fast-forward to 2013, and former Treasury Secretary Larry Summers, fresh from his stint as director of the National Economic Council in the Obama administration, resurrected the term at a speech at the International Monetary Fund in Washington, D.C. And he has been warning the world about it ever since.

Secular stagnation, he says, "may be the defining macro-economic challenge of our times."

Like Hansen in the 1930s, Summers points to declining population growth as one source of stagnation. But he also points to other factors. A big one: Our economy might require less investment than it used to. Think Kodak (the old economy) vs. Instagram (the new economy). Kodak required factories and assembly line workers and trucks and film and film developers and a bunch of other resources to give us photography. Instagram basically needs just an office with laptops and a few hundred smart workers. It needs much less investment.

Meanwhile, there are a lot of savings out there looking for a return, and there don't seem to be enough investment opportunities to sop it all up. As we explained in last week's Planet Money newsletter, a shortage of investment relative to a glut of savings is why we're now in the upside-down world of super-low interest rates.

Summers warns that this world of disappointing growth and super-low interest rates means it will be hard for traditional tools, like the Fed's cutting of interest rates, to rescue us from future recessions. And it could mean the only way we'll get solid growth is if the government attaches the rocket boosters of deficit spending and cheap credit to the economy. Even then, it might look just OK-ish.

The Upside Down Has An Upside

Secular stagnation does have an upside, actually: Low interest rates mean it's supercheap to borrow. That includes for the government. Not only that, but the government might be able to rack up big deficits and give us tons of cheap credit and not cause runaway inflation. That's why respected folks like the former chief economist of the IMF, Olivier Blanchard, are discarding the old rules and saying that deficits don't matter like they used to.

Secular stagnationistas are arguing that now is the time to spend big, on things like roads, bridges and a Green New Deal. That's one way to increase investment in the economy and get us out of this hole. Of course, many disagree. They have faith that new technologies in the pipeline will expand industry, increase investment and productivity and rescue us from stagnation.

Summers makes clear that he believes secular stagnation is not new. Japan has seen it for decades. Before the financial crisis, the U.S. had tax cuts, deficit spending, two wars and massive housing and debt bubbles, and the economy still didn't look amazing. In other words, it's possible that we're not living in the Upside Down. This is the Right-Side Up. The normal place. And those roaring periods of the past — when job-creating technologies, baby booms and expanding frontiers all rocketed our economy to good times — were, in fact, the alternate dimension.

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