Secular Stagnation has been the word of order in major economic gatherings, as developed countries struggle to overcome their low growth rates. As the name says, they stagnated and to overcome this and boost prosperity, especially after the recent economic crisis, the greatest economic minds have gathered in the IMF Research Conference to discuss this issue. Contextualizing the reader, the argument of secular stagnation is that the equilibrium real rate of interest in the global economy has been significantly negative (around -2 to -3 per cent) since at least the mid-2000s, while the actual real rate (at least on bonds) has consistently been much higher than this, despite the efforts of the central banks to reduce it. The consequence is a prolonged period of under-investment in the developed economies, with GDP falling behind its underlying long run potential. The central banks, in order to try and tackle this, have created asset price bubbles (technology stocks in the late 1990s, housing in the mid 2000s and possibly credit today), since this has been the only means available to boost demand. See graph bellow.
The gap between the trend and the Actual GDP lines has led think tanks to suggest that potential output has not actually followed the red trend line, but has instead followed a path sketched by the dotted orange line, reflecting the damage done to the capital stock and the effective supply of labor by the recession.
Recent research tells us that it is unlikely that GPD is still below the orange line and as such central banks have kept their monetary policies aggressively easy (policy makers believe that asset prices are not in bubble territory) and further still, that given the “right” policies, potential GDP can be increased to the red line. One of such Researchers is the Fed’s David Wilcox, who claims that “demand might create its own supply by boosting capital investment and raising labour participation”. Our own ECB stands by the creation and/or acceleration of structural reforms able to increase the growth rate of potential GDP (which have averaged 0.5% per annum).
What secular stagnationists add to this debate is that the problem of under-performance of GDP will last for a very long time, and will not solve itself through flexibility in prices and interest rates, which is what happens in classical economic models (rapidly), and in new Keynesian models (more slowly). The reason for this is presumably that the zero lower bound prevents nominal interest rates from falling, and also prevents prices and wages from adjusting downwards. Further they defend that the normal route through which monetary policy works, by bringing forward consumption from the future into the present, is unlikely to be successful. If the secular stagnationists are right, there will still be a shortage of demand when the future comes around, so there will be a need for ever-greater injections of monetary stimulus (presumably through quantitative easing) in order to avoid an ever-worsening recession. Finally, they say that calls for fiscal action are bound to intensify. Ben Bernanke commented that secular stagnation was unlikely to occur, because there would always be capital projects with a positive rate of return that would be undertaken by the public sector. These projects could be financed by raising public debt at zero or negative real rates of interest, so the debt would be sustainable and the net worth of the government would actually improve. Therefore, in a rational world, public investment would always be used to end the secular stagnation.
Therefore what can we conclude? The low inflation and bond yields appear to lean the battlefield towards the Sec Stag side, but they may be wrong if the real GDP doesn’t correct to either the red or orange (bad case scenario) lines. Attempts to get there would then be followed not only by asset bubbles, but also by rising inflation, and then a massive economic correction. So apparently and essentially, this comes down to the oldest macro-economic question of all: where do policy makers want to take risks, with higher inflation or lost output and employment?
Manuel Piedade #609
Sérgio Rocheteau #620