Accumulation and Secular Stagnation: Part I, Theory

  • Daniel Aronoff


To provide motivation for the theory linking Accumulation to secular stagnation, I review the unexpected breakdown in the transmission of monetary policy that occurred during the late stages of the US housing boom, when long-term interest rates failed to respond to increases in the Fed funds rate. According to the prevailing paradigm of macroeconomics, of which economist Michael Woodford’s textbook Interest and Prices is considered an authoritative source, the breakdown was not expected to occur, in the sense that the Fed was supposed to be able to set the maturity curve of nominal interest rates by manipulation of the overnight Fed funds rate. Professor Woodford explained that

determination of the overnight interest rate would also have to imply determination of the equilibrium holding return on longer-lived securities, up to a correction for risk; and so determination of the expected future path of overnight interest rates would essentially determine longer-term interest rates.3

It is possible to argue, as I have, that the Fed had lost control of interest rates ever since the current account deficit took off in the late 1990s. But prior to the period when the Fed began to increase the Fed funds rate in 2004, there was no inconsistency between monetary policy—which aimed at low interest rates—and long-term market interest rates (which were low). That was no longer the case after the Fed began to raise the overnight rate.


Interest Rate Asset Price Real Interest Rate Excess Demand Full Employment 
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  1. 1.
    Adam Smith, The Wealth of Nations Modern Library Edition (Random House Inc., 1994 [1776]), Modern Library Edition, p. 715Google Scholar
  2. 2.
    Thomas Robert Malthus, Principles of Political Economy 2nd edn reprinted by Augustus M. Kelley (New York, 1964 [1836]), p. 322.Google Scholar
  3. 3.
    Michael Woodford, Interest and Prices: Foundations of a Theory of Monetary Policy (Princeton University Press, 2003), p. 37.Google Scholar
  4. 5.
    See Knut Wickseil, Interest and Prices (London Macmillan Ltd., 1936); F. A. Hayek, Monetary Theory and the Trade Cycle (London Tonathan Cape Ltd., 1933); and F. A. Hayek, Prices and Production (New York: August M. Kelly, 1967).Google Scholar
  5. 7.
    The effect of interest rates on consumption is a core driver of economic fluctuations of the contemporary “New Keynesian” models of the economy, which posits that sluggish adjustments of wages and prices to exogenous shocks to the underlying conditions of supply and demand in sectors of the economy can be offset by central bank adjustment of nominal interest rates. For example, a shock that causes income to contract can be offset by a reduction in nominal interest rates, since (1) sluggish wage/price adjustment ensures the nominal reduction will be a real reduction (at least for some time), and (2) the reduction in real interest rates will induce consumers to increase current spending, by reducing the amount of future consumption that must be foregone to indulge in an increase in current consumption. Thus, the impact of interest rates on economic activity in New Keynesian models is quite similar to their effects in the Wicksell/Hayek model. See Richard Clarida, Jordi Gali, and Mark Gertler, “The Science of Monetary Policy: A New Keynesian Perspective,” Journal of Economic Literature, Vol. XXXVII (December 1999): 1661–1707.CrossRefGoogle Scholar
  6. 11.
    Axel Leijonhufvud, So Far from Ricardo, So Close to Wicksell, Paper given at the 2007 Jornadas Monetarias y Bancarias, Central Bank of Argentina, June 4–5, 2007, session on “Trade-off between Monetary and Financial Stability,” p. 6, emphasis in the original. Scholar
  7. 18.
    “[Fisher’s] diagnosis led him to urge President Roosevelt to subordinate exchange-rate considerations for the need for reflation, advice that (ultimately) FDR followed. Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.” Ben S. Bernanke, “The Macroeconomics of the Great Depression: A Comparative Approach,” Journal of Money, Credit, and Banking, Vol. 27, Number 1 (February 1995): 17.CrossRefGoogle Scholar
  8. 20.
    Ben Bernanke led the reappraisal of Fisher’s idea and emphasized the balance sheet channel of propagating distress into the economy. See Ben S. Bernanke, “Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression,” American Economic Review, Vol. 73 (June 1983): 257–276. Richard Koo has become the leading contemporary advocate of the debt-deflation theory, which he has relabeled “balance sheet recession.” See Richard Koo, Escape from Balance Sheet Recession and the QE Trap: A Hazardous Road for the World Economy (John Wiley, 2014).Google Scholar
  9. 21.
    Several additional costs flow from the contraction in lending, including the costs of reorganizing bankrupt borrowers and banks, and the decline in new ventures or the expansion of existing ones. As an example, Ricardo Caballero and his colleagues showed how, in Japan in the 1990s, banks continued lending to zombie borrowers, with dim prospects for profitable investment, in order to avoid the realization of the loan losses on their accounting books. Channeling loans to zombie borrowers diverted the flow of savings away from productive investments and deterred entry into the industries occupied by the subsidized zombies. Both effects reduced economic growth and job creation. See Ricardo J. Caballero, Takeo Hoshi, and Anil K. Kashyap, “Zombie Lending and Depressed Restructuring in lapan,” American Economic Review, Vol. 98, Number 5 (2008): 1943–1977.CrossRefGoogle Scholar
  10. 25.
    Named after its progenitor, Jean Baptiste Say, an early-nineteenth-century French economist. Note that, in my book Accumulation and Secular Stagnation: A Malthusian Approach to Understanding a Contemporary Malaise (Palgrave Pivot, 2016), I use the term “Say’s Principle” to describe the same concept when the budget equation includes money and financial claims. For an explanation of the historical origins of the two concepts, see Robert Clower and Axel Leijohnhufvud, “Say’s Principle, What It Means and Doesn’t Mean,” Intermountain Economic Review, Fall 1973, reprinted in Axel Leijonhufvud, Information and Coordination: Essays in Macroeconomic Theory (Oxford University Press, 1981), chapter 5, pp. 79–102.Google Scholar
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    See Paul Krugman, “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity, Brookings Institution, Vol. 2 (1998): 137–204.Google Scholar
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    The concept of stimulating demand includes Krugman’s suggestion of credibly setting a future inflation target. See ibid., 137–204.Google Scholar
  13. 33.
    See Axel Leijonhufvud, The Wicksell Connection: Variations on a Theme in Information and Coordination: Essays on Macroeconomic Theory (Oxford University Press, 1981), pp. 131–203.Google Scholar
  14. 34.
    J. M. Keynes, The General Theory of Employment, Interest and Money (The Macmillan Press, Ltd., 1973 [1936]), pp. 210–211.Google Scholar

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