This controversial theory is starting to scare the Fed

You may have not heard of 'secular stagnation,' but regulators and other economists are growing increasingly worried about it.

By MSN Money Partner Aug 12, 2014 4:05PM
Credit: © Chris Hondros/Getty Images

Caption: A financial professional looks at his computer screen on the floor of the New York Stock ExchangeBy Alex Rosenberg, CNBC

Is there something seriously wrong with the economy?

It's a scary prospect, and a concern that's gotten louder and louder over the past year. In economic circles, it goes by the alliterative name of "secular stagnation." And it's a phrase that Fed watchers are likely to hear more and more in the months ahead.

Recent comments by the vice chairman of the Federal Reserve, Stanley Fischer, indicate questions within the central bank about whether the slow growth that has followed the recent recession could reflect, or at least could potentially morph into, longer-term issues within the economy. 

And while Fischer avoided the phrase "secular stagnation" in his Monday speech, Minneapolis Fed President Narayana Kocherlakota is planning to host a November symposium that directly addresses the issue of secular stagnation by name, CNBC has learned.

"I think there's a lot of concern about how long this will last, and I think that's certainly high on the agenda right now. At least people are entertaining that possibility now that it could drag on for longer," said Brown University associate professor of economics Gauti Eggertsson, who authored (along with fellow Brown economist Neil Mehrotra) the landmark paper "A Model of Secular Stagnation," which provides an in-depth explanation of how a long period of low growth could come about.

The theory of secular stagnation was first developed by Alvin Hansen, who wondered in the midst of the Great Depression whether diminishing investment opportunities in a maturing economy would stunt economic growth and permanently prevent full employment -- at least in the absence of robust government intervention, which soon came in the form of the second world war.

These theories have found a new life in the aftermath of the so-called Great Recession, as the U.S. is experiencing (albeit to a much less dramatic degree) slow growth over a relatively long time period.

In November 2013, noted economist Larry Summers (who was considered, alongside current Chair Janet Yellen, a leading candidate to head the Fed) began to invoke the same phrase in arguing that the interest rate that the economy requires has fallen below zero.

The problem is that it is very difficult for nominal interest rates to fall below zero due to a constraint known as the zero lower bound. The upshot? Even with the Fed keeping short-term rates just above zero, market interest rates cannot possibly create adequate demand for loans, and thus the economy stagnates.

Without embracing the secular stagnation thesis, in Sweden on Monday, second highest-ranking Fed official Fischer gestured toward those concerns.

Noting slow growth in "labor supply, capital investment and productivity," Fischer warned that "This may well reflect factors related to or predating the recession that are also holding down growth" and noted: "How much of this weakness on the supply side will turn out to be structural -- perhaps contributing to a secular slowdown -- and how much is temporary but longer than usual lasting remains a crucial and open question."

"There was a level of concern on that point that I don't think we generally hear," said Nicholas Colas, chief market strategist at ConvergEx, referring to Fischer's speech.

The stagnation debate will also be addressed by a new eBook entitled "Secular Decline," which is due to be published on Aug. 18, and hosts contributions from Paul Krugman and Nomura's Richard Koo, in addition to Summers, Eggertsson and Mehotra, and others.

But for those who take issue with the secular stagnation theory, these dour questions are a natural consequence of recession-era thinking.

"I think it's inevitable that when you're in a slump for this long, people will start looking for answers. It's completely understandable but I think we're being way too pessimistic," said David Beckworth, assistant professor of economics at Western Kentucky University, who recently wrote an opinion piece on The Washington Post's Wonkblog entitled "Here's why Larry Summers is wrong about secular stagnation."

Beckworth is with the stagnation thinkers in believing that "the Fed has not aligned its rate with where the market-clearing rate is. And until that takes off, the economy will still be in a slump," he said. "But to me, maybe I'm an optimist, but I see demographics and technology pointing in the direction" of sustained growth.

And when it comes to what the markets ultimately care about in the short term -- Fed policy -- there's one thing nearly everyone can agree on: fresh concerns about secular stagnation are likely to make the Fed even more nervous about reducing accommodation too soon.

"What Fischer is saying is that the economy's growth rate is slow, we're not sure how much is structural, and unfortunately the cyclical can become structural," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. "Reading between the lines, it seems he would be sympathetic to Yellen's view that monetary policy has a serious role to play," in avoiding economic stagnation.

Fischer's speech "did suggest that he's not in any rush. There's no indication that he wanted to end any of these policies or even put the brakes on, which I thought was encouraging," Eggertsson said.

That has clear ramifications for investors everywhere.

"If they're worried about growth, then rate hikes will be kicked further down the road, and rates will trend lower and the equity market stays somewhat bid," said Rich Ilczyszyn of iiTrader, who added: "But I'm hoping that he's wrong."

While the issues Fischer bring up are serious, however, the economist also struck a hopeful chord.

"It is unwise to underestimate human ingenuity," Fischer said.

More from CNBC

Aug 12, 2014 4:35PM
"Is there something seriously wrong with the economy?"

Well yes, for well over a Decade now, the WAGE Gap has soared from 40 to 1 to now over 400 to 1. Now you can call that Free Markets or  whatever. However, that fact of the matter is this, when Real Consumer aren't making enough in Wages to support the overall economy, Companies have to resort to Financial Engineering to Cook the books.

Henry Ford stated it best, If I don't pay my workers a Fair Wage, whose going to buy my products. Nothing has changed.
Aug 12, 2014 4:46PM
If the Fed would let the market determine rates, we would get them back normal.  The savers will earn interest and when their money is making money, they will start to spend.  Another perk is the savers, most in retirement age or close to it, will be able to retire.  This will open up jobs for the unemployed or under employed and real job growth will take place. .  Then as the law of supply and demand takes over, the prices of goods will stabilize.   Its really A SIMPLE SOLUTION.
Aug 12, 2014 4:24PM
This is why I am really interested to see what the government and FED does when the next recession hits, especially if rates are still near zero.  Every recession the rates are required to go lower and lower to get us out of it.  Lesson is that maybe at the very beginning of this bubble fed manipulated economy the fed should have let the market settle things out instead of constantly trying to bump it higher, for the eventual huge crash.
Aug 12, 2014 4:41PM
Now let just cut through all the BS. All the Western Central Banks are Trapped in a low rate manipulation process that can't end because of massive Global Government and Corporate Debt. End of story. By the Way, same for China and Japan. This won't end well, all the Central Banks understand this. Their only Goal, make sure the Elite make out like bandits before the actual Crash and Burn.
Aug 12, 2014 5:01PM
The result of offshoring both jobs and profits, inversion to headquarters in another country, and the devaluation of
making something to simply moving money around to gain short term bonuses. 
Without growing middle-class jobs, what did they expect?

Aug 12, 2014 4:32PM
And they did not see this coming?

Please they knew when they put all that printed money in every month they were faking a recovery to make Obozo look good.

And now look a bigger mess..

Hope all you Obozo voters are happy........ I'm not......

Just think if they took that money to build new roads, dams, schools they would have made jobs and helped the economy but no Obozo just handed the rich the money and screwed the middle class. The poor don't care they still get their free stuff.....

Aug 12, 2014 4:36PM
Americans are screwed....We have Obama...
Aug 12, 2014 4:59PM
The FED is a consortium of the banking industry!  The banking industry looks out for themselves first!  Get the Gov't to print free money to make up for your "ponzi" scheme failures and loan it out at exorbitant  rates to consumers and businesses who YOU induced into too much indebtedness in the first place, rake in billions in profits, and not have to pay any thing on savings (0.01%) kept in your institutions!  The banking industry is no more than LEGALIZED THEFT!  Bring back the use of the guillotine !  That would clean up this mess really quickly!
Aug 12, 2014 4:40PM

Larry Summers, Krugman, and the like: These Keynsians and their bubbles were the cause of the recession in the first place. The only things larger than the massive financial bubbles they've created, are their egos. Certainly, their giant inflated egos would never allow them to admit that it's their fault, that they could be wrong, or that their policies failed. No, no, no. So all they can do is double down, and of course now they are saying we need even lower interest rates, lower than zero? What pay people to borrow money and gamble it in the stock markets, so they can blow an even bigger bubble?


We've tried their way for many years. It's not working. Try the opposite approach. Maybe it will work. But the only thing more important to them than fixing the economy, is that they be right. They are nuts!

Aug 12, 2014 5:46PM
"is there something seriously wrong with our economy?"

Let's see...household incomes have dropped, we still have fairly high unemployment, the debacle known as the ACA is exactly the opposite of affordable, The Fed has trashed the US dollar, and the country's debt is predicted to hit $20 trillion when Obama leaves office...nahhhhh! Things are just hunky dory!

Aug 12, 2014 5:11PM
The Fed is $4trillion in debt and going more every day. The USA is borrowing money from China to help everyone in the world get guns and bombs to kill each other. We will pay for this!!  It is a matter of time before bankruptcy comes to the USA.
Aug 12, 2014 5:29PM

"Secular stagnation"? I'd prefer to believe what grandma always said about leading a horse to water.

You can stimulate the supply side all you want, but if enough people are too worried to commit, you get nothing.

We are in a slow or zero growth phase for one reason only: NO ONE with money to spend or invest has any confidence that this current administration knows what it is doing. Uncertainty abounds (note number of TV shows about hoarding, prepping, or general doomsday scenarios).

We need another Reagan soon; the current occupant of the White House knows absolutely nothing about leadership. 

Aug 12, 2014 5:19PM

so by rights we should have slid into a deflationary period rather than a manipulated recovery. 


instead the average person slid backwards anyway (old jobs gone, new jobs are weak), while product prices and inflation continued upward.  and don't even mention CEO pay (but i'll mention it anyway). 


"""The problem is that it is very difficult for nominal interest rates to fall below zero due to a constraint known as the zero lower bound. The upshot? Even with the Fed keeping short-term rates just above zero, market interest rates cannot possibly create adequate demand for loans, and thus the economy stagnates."""

Aug 12, 2014 6:07PM

The Crony Capitalism that Congress has embrased has terrible side effects.




Airlines had their lobbyist pay off Congress so they could consolidate. The end product is no more competition for the 4 major  U.S airlines. Airfares go up over 50% in a couple of years. . Congress institutionalize bad airline service while increasing airfares from the lack of competition.


The result the airlines fly their crappy little planes around at crazy prices. $858.00 coach from Chicago to Newark that I saw today.


Hotels, car rentals restauarant and eveyone tied to the travel industry suffer because people cannot fly. It is just too expensive. So the travel industry suffers because Congress (the most organized criminal operation in the world) allowed after being paid off for the airlines to eliminate competition.


Congress and the 4 airlines make a ton of money. The rest of lose. I think the mafai term is "racketterring".


Congress is now the newest form of organized crime. Pay off Congress and you win. Everyone else can lose, but Congress sells out America for their  own  personal  gain.


Congress is doing the same thing with cable companies, banks,  insurance companies and a ton of other industries.


Get rid of Crony Capitalism, Term limits for Congress. Publically paid elections for Congress. Versus privately owned criminals AKA   Congress and their billionaire buddies and big corporation now have.


The Criminals are killing our economy. The demand is there.

Aug 12, 2014 6:38PM
If all the economists were placed end to end they would not reach a conclusion.  Every one of these boys seem to be always right and always wrong at the same time on every issue.  And nobody gets fired.  It's akin to astrology.
Aug 12, 2014 5:01PM
Regulate what? That is a joke!  What is other economists?  What is secular stagnation?  These PHD's, in attempting to know something, are as ridiculous as our whole culture as become.  Our educational system is as defunct and bankrupt as our Constitution has become.  Makes me ill.  Nice breeze coming in and maybe we need more nice "breezes" and not the idiocy given us all the time. WE DO NOT BELIEVE YOU, ANYMORE!
Aug 12, 2014 6:15PM
I prefer the old name of Obamanomics.  Secular stagnation just doesn't have the same ring to it.  It fails to describe who is responsible for this EPIC FAILURE.
Aug 12, 2014 11:43PM

Here's what's wrong with this economy

1. In 1971 1 out of 49 americans were on food 1 out of 6 americans on food stamps.

2. High energy prices

3. High food prices

4. High health care cost

5. High taxes

6. Skyrocketing College tution

7. Most full time jobs gone

8. Most manufacturing jobs gone to Asia

9. Wages not keeping up with inflation

And you think anything is going to change?

Aug 12, 2014 6:09PM
I guess economists always have to worry about something.  First, it's an economy that is growing too fast, with the concern it will lead to runaway inflation.  Then it's the economy slowing down, with the risk of deflation.

We are in a period of consistent slow growth.  Isn't that considered the utopia of economic development?  In my way of thinking it's far superior than a volatile cyclical economy that races ahead only to crash after a year or two of rapid growth.

There's more important things to worry about . . .
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