Spectre of secular stagnation

Heavyweight economists have raised the spectre of poor growth continuing around the world for years to come.

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Published: Sat 25 Oct 2014, 9:47 PM

Last updated: Fri 3 Apr 2015, 9:44 PM

Former US Treasury Secretary Lawrence Summers and Nobel laureate Paul Krugman are among prominent intellectuals who have compiled a study into “secular stagnation”, an idea that suggests advanced economies may not be heading back to normal in the wake of the global financial crash. Broad changes to their populations and the way money is shared have led to fundamental weaknesses — which have only been masked by speculative bubbles over the past two decades.

“Normal”, in this case, involves a situation where prices rise when people spend more money, as increased demand pressures prices higher. To control this inflation, central banks can raise interest rates. Then investment and buying are discouraged as borrowing becomes more expensive, while savings are encouraged because you get higher returns. Money is diverted from spending to saving, cooling an economy.

Conversely, central banks can lower interest rates to increase economic activity until efficient levels of employment and inflation are met.

The big problem happens when economic activity is so sluggish that interest rates would need to go below zero to spur enough spending in the economy.

But negative interest rates — situations where you get to pay back less money than you originally borrowed — are in reality impractical. Few would ever lend in such circumstances.

Many advanced economies are in such a bind right now, with central bank interest rates at or near zero. And significantly, the hypothesis of secular stagnation is now suggesting that this situation isn’t a mere reflection of a lingering recession; it may turn out to be a lasting phenomenon.

Summers suggests these economies are suffering from a long-term drop in spending growth, for several reasons.

First, slower population increases are simply sapping the growth in demand for stuff.

Second, the cost of investing in new technologies is less than they used to be: today, cutting-edge innovation or capital investment can amount to just a mobile app — rather than an industrial-scale factory. Firms don’t need to spend as much as they used to.

Third, rising inequality is putting more money in the hands of the rich, who don’t spend as much as the poor would.

These factors contribute to lowering what Summers calls the full-employment real interest rate, or the interest rate level that would spur a full-employment-worthy level of economic activity — and this level may have dipped below zero.

The economists who are sounding warnings about secular stagnation say the significance is in economies becoming mired in “lost decades” — the way Japan has stagnated since the early 1990s. Moreover, the new reality may make obsolete the toolbox of traditional monetary policies which central banks have been using to steady their economies.

Importantly, Summers notes that if it weren’t for the wild lending and house price bubble of the 2000s, growth in the US during that period would have been “inadequate”. The 1990s were similarly illusory, he says, the decade’s growth having been driven by Internet and stock market bubbles. “So it has been close to 20 years since the American economy grew at a healthy pace supported by sustainable finance.”

The world economy faces a complex, deeply entrenched set of challenges, and the biggest concern may be whether governments — their politicians, bureaucrats and, notably, their electorates — can delve deep enough to tackle what may be a looming economic wall.

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