The falling natural rate is no mystery

“The natural rate is going down because we moving into period of secular stagnation.”

“excess savings”

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This reminds me of Dr Diafoirus in Moliere’s play The Hypochondriac, who declared that opium puts people to sleep because “it possesses a soporific power which induces sleep”.

- A second explanation, much favored by Keynesians, is that there are in the world. As a result policymakers should proceed to the euthanasia of the rentier by maintaining abnormally low rates.

- Other people talk about maintaining that older people are unproductive (which I particularly resent).

- But probably the most intellectually-contorted explanation I have come across came from one the great luminaries of modern “economic science” (an oxymoron if ever I heard one), who said that “

the growth rate is falling because people believe we are entering an extended period of low growth”.

Mixing Keynes and sentence is really quite an achievement.

Needless to say, none of these fellows saw this coming, and none can offer a coherent theory of what is happening. Happily, they don’t need to. Wicksell outlined everything we see today almost 120 years ago. Wicksellian theory explains that growth in an economic system happens if only those who have a return on invested capital higher or equal to the natural rate have access to capital. If undeserving investors get access to capital, it means that the entrepreneurs who really should have access get crowded out, and that a large share of the available capital is wasted. As a result, the structural growth rate of the economy must fall.

There are two ways of allowing people without the necessary rate of return to get access to capital. The first is to hold the market interest rate way below the natural rate. This is what central bankers are doing today. But contrary to conventional central bank thinking, abnormally low rates do not lead to an acceleration in growth, but rather to a collapse in the structural growth rate of the economy. So the first reason behind the structural stagnation we see today (which

single will morph into a secular depression if these policies continue) is the asinine monetary policies followed for the last 20 years by the US, Japan, and Europe (via the euro).

But there is a second reason, one on which I did quite a lot of work a few years ago.

These days, more and more spending is being done by entities which can borrow regardless of their return, and which are immune to the creative destruction process. I mean, of course, governments.

The solid weight of historical evidence allows me to advance a law to which I have never yet found any exception: if government spending goes up as a share of GDP, the structural growth rate of the economy goes down. The chart shows this law in action in the US, but I could equally well have shown the same chart for Japan, France, the UK and others.

There is a law in economics which states that at a certain point in time the marginal return on additional spending begins to go down for every increase in spending. In consequence, we can assume that the marginal return on any increase in government spending first declines, and then turns negative. It seems obvious that the marginal return on increases in government spending is now negative in, for example, Japan and France.

The implication is clear: if policymakers want GDP growth to go up, then mathematically they should cut government spending. Of course, that is not going to happen. Instead, it seems that what we are likely to see in developed countries is increases in government spending in an attempt to deal with the supposed “structural lack of demand due to excess savings”. And as we have seen, it is a safe bet that any such increases in government spending will lead to a fall in the structural growth rate, rather than an increase.

In turn, this decline will cause central banks to keep interest rates exceptionally low, a policy which itself will lead to lower structural growth rates, and still higher government spending facilitated by the low interest rates. The consequence would appear to be an economy locked into abnormally low rates, ever-increasing government spending, and a permanently declining structural growth rate. Except of course, that is not sustainable — and Wicksell has told us already how it will all end.

When the structural growth rate falls below zero, then the leveraged players in the economy — those who should not have had access to capital in the first place — will go bust and there will be a financial crisis. And the longer it takes to happen, the more traumatic it will be. To put it bluntly, if Wicksell is right, then Keynes was 100% wrong. And the policies the high priests have followed everywhere around the world for the last 20 years have been 100% Keynesian.