Seven years after the 2008 financial crisis, average growth is sluggish or stalled in many advanced nations. Economists are in a furious debate as to why and what to do about it.
Such poor performance isn’t for want of trying, at least by the major central banks. Since 2008, most central banks in advanced nations have slashed their interest rates to near zero. The biggest central banks have resorted to extraordinary measures to buttress beleaguered financial systems.
Between them, the US Federal Reserve, the Bank of Japan and European Central Bank have increased their balance sheets from US$3.5 trillion to almost US$10 trillion by printing money to buy bonds, and their combined balance sheet is expected to reach about 35 per cent of their nations’ collective gross domestic product (GDP) by 2016.
As the governor of the Reserve Bank of Australia (RBA), Glenn Stevens, pointed out, such moves were testament both to the severity of the financial crisis and the paucity of other options.
Yet although monetary policy has been effective in helping to stabilise financial markets, neither businesses nor consumers have responded to very low interest rates in the expected way.
“Six months ago, I warned about the risk of a ‘new mediocre’ – low growth for a long time. Today, we must prevent that new mediocre from becoming the ‘new reality’.” Christine Lagarde, IMF managing director
In the pre-crisis world, central banks could encourage or deter spending by manipulating interest rates. When rates went down, cheaper credit would encourage people to bring forward their spending.
But hard economic times and an uncertain outlook have made companies and households wary about spending and more focused on reducing their debt. As Stevens puts it, central banks have found themselves increasingly “pushing on a string”.
Even 0 per cent (or less) interest rates haven’t been able to get economies moving. And where there has been spending, it has too frequently been in ways that push up prices for existing housing, rather than going into areas which could create jobs.
This is the problem economists have dubbed “secular stagnation” – a stage where a market economy falls out of that more familiar cycle of boom and bust to become stuck in a period of negligible or zero growth.
In advanced economies, the generations since World War II have grown up assuming a world of inevitable economic progress. Is it time for a mind shift, to accept that advanced nations will return permanently to much slower growth?
Stagnation or a savings glut?
Faced with the prospect of stagnation, central bankers have been issuing increasingly loud warnings that monetary policy alone cannot be expected to retrieve the situation and restore world growth.
However the question of whether we’re truly in a period of secular stagnation has sparked a very public blog war between two of the leading economists of our time – the former US Treasury Secretary, Larry Summers, and the former chair of the US Federal Reserve, Ben Bernanke.
Summers champions the stagnation argument. He says firms in ageing economies with slower population growth and a shortage of new business ideas are deciding to scale back investment even though savings are plentiful. That, he says, is holding down employment, consumption and growth.
“Things looked far worse in 1938 and pretty bleak in 1982, but if you had predicted permanent stagnation at either time, you would have been woefully wrong.” Ed Glaeser, economist
“It is worth taking seriously the possibility that we face a chronic problem of an excess of desired saving relative to investment,” he wrote in an April essay.
Such a slump could already have been happening for two decades, partially disguised by occasional asset bubbles, including the tech wreck of the late 1990s and the property boom last decade.
But this isn’t the only possible diagnosis.
The same features consistent with secular stagnation – slow growth and weak inflation that resists the effect of low interest rates – could have a different cause. When he launched his blog in March, Bernanke immediately suggested that the US and other advanced countries are suffering from the effects of an international glut of savings.
This glut, fed particularly by East Asian and Middle East cash, has pushed down interest rates and buttressed currencies, making imports cheap and driving large trade deficits.
The debate has pulled in many other well-known economists, including Harvard professor Ken Rogoff, who takes a view closer to Bernanke than Summers.
Rogoff says the world is in an adjustment phase after the 2008 crisis, with governments and businesses still clearing an overhang of debt built up in the bad years. Economies are simply showing their scars, and while recovery may be uneven, things will improve.
Olivier Blanchard, the chief economist at the International Monetary Fund (IMF), is less optimistic about revival. He wrote recently on the IMF blog that he too thinks that “debt overhang is indeed playing a role”. But Blanchard doesn’t expect real interest rates to start rising anytime soon. “I am closer to Summers … than to Rogoff,” he wrote.
“The real possibility that we’ve entered an era of secular stagnation requires a major rethinking of macroeconomic policy.” Paul Krugman, Nobel Prize winner in economics
In April, Blanchard’s boss, IMF managing director Christine Lagarde, warned against making the “new mediocre” (low growth for a long time) into the “new reality”. Borrowing from John F Kennedy, she declared: “Comfortable inaction is what must be avoided.”
Placing policy bets
A lot hangs on whether Summers or Bernanke is correct, because the policy prescriptions they imply are very different.
If the US, Europe and Japan are indeed stuck in a period of secular stagnation, as Summers argues, the malaise cannot be fixed by record low interest rates alone. To break out of this cycle, governments should increase their spending, even if that means going deeper into debt. And they are able to do so because record low real interest rates make it easy to service debt. Any government investments that make any sort of return will pay off.
The idea has echoes in the G20’s infrastructure investment agenda, which will be used to help achieve the goal of a 2 per cent increase in global GDP over the next five years. Paul de Grauwe, a professor of international economics at the London School of Economics, typifies those who back this approach.
He argues governments in Europe, especially, need to urgently raise public investment if a whole generation is not to be condemned to high levels of long-term unemployment, at huge economic, political, social and human cost.
De Grauwe has no doubt that the eurozone’s response to the crisis – forcing tough austerity programs on debtor countries such as Greece, Spain and Portugal – is responsible for the region’s economic stagnation, and that Europe’s low-growth woes are weighing on the US, UK and China. “This is the time to reverse the ill-advised decisions made since 2010 to reduce public investments,” he writes.
“The presumption that normal economic and policy conditions will return at some point cannot be maintained.” Larry Summers, former US Treasury Secretary
Bernanke’s solution is different. He accepts that more infrastructure spending would be “a good thing”, but thinks the real solution will be reducing savings in major exporters of capital such as China and Germany. This could be done by increasing the value of their own currencies and reducing their trade imbalances with countries such as the US.
For Bernanke, the current period of slow growth is most likely due to temporary headwinds that, he says, are already starting to dissipate. He is sceptical that the US economy is in a period of secular stagnation, and is wary of weighing governments down with greater debt. He doubts that real interest rates will remain so low in the long term, and does not want to burden future generations with even more red on the balance sheet.
Economist James Morley from the UNSW Australia Business School has similar concerns. He points to Japan’s unsuccessful attempts to stimulate its way out of stagnation. “Japan has undertaken massive debt-financed infrastructure spending and this has not exactly produced a booming economy,” he wrote recently. And its government must now pay interest on a ballooning debt.
The IMF has recently echoed some of Summers’ thinking, concluding that governments need to do more to stimulate demand. The Reserve Bank of Australia is closer to Bernanke’s position, at least as far as Australia is concerned. RBA leaders argue that rate cuts are laying the foundations for a resurgence in stagnation-busting consumption and investment.
“Low interest rates are supporting spending in the economy,” RBA deputy governor Philip Lowe said in May. “In time, stronger consumption growth and a continuation of the pick-up in residential construction should lead to a lift in business investment.”
The new mediocrity?
Of course, the economy looks stagnant now because we are used to growth rates of 3 per cent and above. Several economists have argued growth is permanently slowing. US economist Robert Gordon has been arguing that the world has long been running out of the productivity growth that spurred growth from 1750 to 1970. He sees the years from 1920 to 1970, in particular, as a period when many innovations came together to supercharge growth – everything from affordable cars and widespread electric lighting to air conditioning and indoor toilets.
Gordon also warns that “headwinds” including demography, inequality, lack of educational improvement and government debt are pushing the US towards a slower-growth future.
The Bank of England’s chief economist, Andrew Haldane, has similar worries about most Western economies. He suggested in a speech earlier this year that future growth “risks becoming suspended between the mundane and the miraculous”.
But other experts, including economist Ed Glaeser, warn against drawing too many lessons too quickly from the post-2007 era. “It is hard to know whether the past painful eight years represent the trend or the cycle,” he wrote in a recent essay on stagnation. “Things looked far worse in 1938 and pretty bleak in 1982, but if you had predicted permanent stagnation at either time, you would have been woefully wrong.”
“Unless the whole world is in the grip of secular stagnation, at some point attractive investment opportunities abroad will reappear.” Ben Bernanke, former US Federal Reserve chair
The phrase “secular stagnation” itself was coined in the late 1930s by US economist Alvin Hansen. Hansen thought the good times had run out. Of course, he was thoroughly wrong: the world was still to endure a world war, but the years after 1946 brought some of the fastest growth ever.
Today’s economy is not unlike that of the late 1930s. Economists, central bankers and politicians don’t really know what is happening in the world’s biggest and most important economies. But their debate could have far-reaching implications for economic growth and the living standards of billions.
The growth numbers
According to the International Monetary Fund, the world’s gross domestic product grew by 3.4 per cent last year – a little below the long-run average of 3.7 per cent – and it expects only a marginal improvement to 3.5 per cent this year.
But that unimpressive average has been pushed up by China and a few other fast-growing economies. The world’s most advanced economies have had much weaker growth.
The eurozone grew at a meagre 0.9 per cent last year and is expected to pick up to a still lacklustre 1.5 per cent this year. Japanese output actually shrank.
The US (2.4 per cent in 2014) and UK (2.6 per cent in 2014) have been among the better performing major economies, but even here growth appears fragile – both had a very weak start to 2015 that rattled markets and dampened the outlook.
This article is from the July issue of INTHEBLACK