Growth Debate

The Big Mistake of the Keynesians

ARCHIV - Passanten gehen am 06.06.2014 mit Einkaufstüten durch die Innenstadt in Hamburg. Foto: Bodo Marks/dpa (zu dpa "Niedrige Inflation - Verbraucher dennoch besorgt" vom 13.08.2014)) +++(c) dpa - Bildfunk+++
People need more time to get back to historic spending levels, Mr. Rürup writes.
  • Why it matters

    Why it matters

    A long period of weak growth in Europe might trigger a new round of economic stimuli.

  • Facts


    • Many industrial countries today have weak growth, high unemployment, flat inflation, low interest rates but high per-capita income.
    • Keynesians such as such as former presidential economics advisor Larry Summers call for governments to stimulate demand
    • Today’s tepid growth can be ascribed to a typical occurrence after severe finance- and debt-crises, the writer argues.
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Weak growth, high unemployment, low inflation, low interest rates but high per-capita income describe the situation in many industrial countries today.

Many economists are reminded of their studies of economic doctrines throughout history, and especially of Harvard economist Alvin Hansen and his theory, presented in 1938, regarding “secular stagnation.”

Mr. Hansen made the observation that the American population was only increasing slowly and, years after the Great Depression, unemployment had still not declined. Mr. Hansen, who has been called the American version of British economist John Maynard Keynes, considered the slow rise in population as a cause of sluggish investment and the related, stubbornly enduring underemployment.

But as economic developments after World War II refuted this hypothesis, widely-used economic textbooks made no mention of the phenomenon of secular stagnation – at least not until recently.

In 2011, the Nobel economics prize wineer Paul Krugman rediscovered the term. But it was Harvard professor and former U.S. treasury secretary Lawrence “Larry” Summers who, in a lecture in 2013, pulled secular stagnation out of the heap of outdated doctrines and ignited a new debate about growth.

It’s possible to consider the pause in growth as a typical occurrence after severe finance- and debt-crises.

For Keynesians such as Mr. Krugman and Mr. Summers, imbalances always come from a weakness in demand (total spending in the economy). Since the 2008 global crisis, the world economy has been caught in a liquidity trap. An interest rate that would lead to a level of investment that in turn would guarantee the full use of production potential is in the negative realm.

Therefore, the Keynesians conclude, demand for investment is far too low, and with zero-interest policies the central banks have exhausted their possibilities.

These economists call for governments to stimulate demand with credit-financed investment programs. Moreover, they argue the inflation targets of the central banks should be raised and, through the elimination of hard cash,  they should be given the possibility of forcing rates of interest far into the negative realm.

Luckily, in addition to the Keynesians, there are also economists who attribute greater importance to the supply aspects of an economy rather than demand. They interpret the current sluggish growth in entirely different terms.

The fact is it’s possible to consider the pause in growth as a typical occurrence after severe finance- and debt-crises. Moreover, in view of falling prices for industrial commodities, a real decline in levels of investment cannot be unambiguously discerned.

In addition, increases in productivity and prosperity brought about by information technology are insufficiently registered in official economic statistics. Google might be one of the world’s most valuable companies, but its contribution to gross domestic product is likely to be judged quite modest.

An argument can be made that supply conditions are crucially important for a country’s growth prospects. Therefore, a demand stimulation through an even looser monetary policy is likely the wrong response to the current weaknesses. Perhaps today’s extremely lax monetary policy is even partly responsible for the economic misery, because very cheap money stimulates not so much real investments as credit-driven speculation. It also delays the reduction of public and private debt and puts the brakes on structural change.

Nevertheless, it would be wrong to regard low interest rates and debt-financed growth programs collectively as flashes in the pan. The smoothing of economic volatility can definitely have positive effects on long-term economic growth.

But Mr. Summers and Mr. Krugman see a weak, long-term trend in growth, not a cyclical slowdown. The correct answers to these questions would be a longer working life, vigorous policies promoting education and technology, growth-friendly management of companies, stabilization of banks and a reduction in governmental and private debt but not even more excessive monetary and fiscal policies.

Paul Samuelson, the 20th century’s preeminent economist, once rightly observed: “God gave economists two eyes: one for supply, and one for demand.”

It seems that many advocates of the secular-stagnation thesis wear a blinder over their “supply eye”. Opposition to these attempts to bring the Trojan horse of secular stagnation into the euro zone  and to launch a grand Keynesian experiment is amazingly low – unfortunately.


Bert Rürup is president of the Handelsblatt Research Institute. To contact him:


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