Transcript Secular Stagnation

NS3040
Fall Term 2014
Risk of Secular Stagnation
Overview I
• Oxford Analytica, “Risk of Secular Stagnation is Rising,”
March 7, 2014
• As pace of global recovery continues at a slow pace
concern that developed economies may enter a period of
“secular stagnation.
Idea put forward by modern Keynesians, Larry Summers
and Paul Krugman
• Relies on Keynesian intuition that demand is currently
insufficient to
• Match idle capacity
• Boost economic growth, or
• Lower unemployment
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Overview II
• Stylized Facts
• More than five years after the global financial crisis,
• GDP growth across advanced economies is weak,
• Unemployment stubbornly high
• Inflation low, threatening to turn to deflation
• Rising income inequality and foreign reserve
accumulation are
• Contributing to lower consumption and excess savings at global
level
• Which has dampened the impact of historically low interest rates
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Overview III
• Main propositions of the stagnationists:
• Unless week demand is addressed, supply side reforms that
increase capacity will not boost growth
• Increased capital requirements by banks will constrain credit,
diminishing the impact lower borrowing costs have on
investment
• Addressing income inequality through tax reform would help
boost domestic demand
• The worry is that
• secular stagnation might result in a structurally lower economic
growth potential,
• condemning advanced economies to years of growth to weak to
reduce unemployment
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Causes of Secular Stagnation
• Summers identifies the global savings glut – a chronic
shortage of investment relative to savings
• Main cause of weak demand and slow growth
• Income inequality
• Growing disparity between income earners at the top and bottom
of the income distribution has an adverse impact on global
demand
• The very rich consume proportionally less of their income than
the middle class or poor
• This drives savings up and global demand down.
• Foreign reserve accumulation
• The built up of foreign reserves by countries relying on export led
growth rather than domestic demand reduces consumption.
• This boosts savings and hurts global demand
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Solutions to Stagnation I
• A number of broad policy solutions have been put forth
to counter secular stagnation:
• Real interest rates
• One solution to boost demand would be to further lower real
interest rates (interest rates minus inflation)
• While interest rates have fallen in recent years, equilibrium
interest rate (that is consistent with full employment) has fallen
further
• Implies that in order to stimulate the economy by encouraging
borrowing, real rates must fall far below the low – and in some
cases negative – rates currently seen
• Lowering real rates could be achieved by central banks using
unconventional monetary policy such as quantitative easing (QE)
• Another solution: lower real rates by increasing inflation
expectations (anticipated inflation)
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Solutions to Stagnation II
• Fiscal Policy
• Public stimulus measures – similar to those seen in the
recession could be effective in ending secular stagnation
• Public authorities could breathe life into sluggish economies by
increasing investment directly
• Summers preferred method for addressing securer stagnation
• Not only does public infrastructure investment not require an
institutional change, makes sound economic sense given that
many governments face negative real rates with borrowing in
financial markets.
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Solutions to Stagnation III
• Structural reforms
• Advocated by the OECD in 2014 Report “Going for
Growth.
• Recommended measures include
• Lower product market regulation
• Enhancing competition
• Reforming pubic education systems and further liberalization of
labor markets
• Such measures would be effective in boosting capacity and
raising growth potential in the long run.
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Limitations to Solutions I
There are serious limitations to the policy responses offered
by the Keynesians to counter secular stagnation:
• Zero-lower bound
• Central banks lose the ability to stimulate the economy when
interest rates are at or near zero.
• Even quantitate easing (QE) measures in this environment have
not been sufficient to boost growth
• Philosophy is to get investors to move into riskier assets – same
problem that caused the 2008 collapse in the first place
• Bubbles
• Extremely low interest rates and QE might actually become
counter productive
• Have caused prices of assets to increase rapidly
• May create bubbles in housing and assets triggering financial
stability
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Limitations to Solutions II
• Public Finances
• In much of developed world there is very little room for maneuver
when public debt is close to or higher than 100% GDP
• Currently the case in the U.S. United Kingdom and France
• Political Consequences
• Unlike monetary policy fiscal policy solutions require democratic
debate and political conseqnces
• Might be emerging consensus on fiscal policy at the global level
(IMF, G20), but clearly lacking in the US and EU
• EU rules government public deficits and debt prevent any fiscal
stimulus from being implemented
• Political gridlock between Democrats and Republicans has
prevented any public investment strategies since the passing of
the 2009 stimulus bill
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Limitations to Solutions III
• Timing
• Investment in innovation and knowledge that raises the
growth potential of the economy is always beneficial, but
will do little to foster demand in the short tun
• Of these limitations the lack of political will and
consensus is the most serious as infrastructure
investment would likely be the most timely and effective
way of addressing secular stagnation
• Institutional deadlocks prevent this.
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Conclusions
Summing up
• Policy solutions to address secular stagnation – and
slow growth more generally – appear few and far between
• The United States and EU are very unlikely to engage in
the kind of strategies – particularly pubic investment that
might reduce secular stagnation risk
• U.S. political system is polarized
• Tax policies to smooth out income distribution and raise
purchasing power of lower income groups a non-starter
• Increased minimum wage a very inefficient way to do this
• EU is constrained by strict fiscal policy rules
• Without political consensus advanced economies could
risk entering a period of prolonged structurally soft
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growth.