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a blog from young economists at Nova SBE



Current Account Deficits within a Monetary Union

In Europe, peripheral countries whose investment opportunities are significantly limited by the reduced level of the domestic saving rate would have, as conventional theory would predict, much to gain with a monetary union which allowed for reduced premiums to foreign finance. Even with the worldwide liberalization of capital movements, the volatility of nominal exchange rates restricts investors’ willingness to allocate their savings in foreign economies as the returns of such investments depend considerably on the exchange rate fluctuation, in turn prone to a great deal of uncertainty.

Therefore, the fixed exchange rate regime entailed by the EMU membership, by ruling out the risk of exchange rates depreciations, would give such countries access to northern European finance at an almost premium-free interest rate and allowed then to invest more than what their consumption pattern made possible. This capital inflow indeed occurred in the southern European countries such as Greece, Ireland, Portugal and Spain (GIPS). With the wisdom of hindsight, it is clear that the accumulation of external liabilities thus induced was not sustainable. The question is whether it could have been.

The logic of sustainably enduring large current account deficits is that foreign investors who channel funds into a given economy do it because their capital would face diminishing returns in richer countries, where the capital stock is higher. Those being allocated in high productivity sectors of the less capital abundant economies, these would then be able to produce the resources needed to cope with their external liabilities.

The surge of capital inflows verified in the southern European countries due to intra-Euro zone lending and borrowing lasted, and at an increasing pace, from 1999 to 2009, that is, during the Euro first decade. It could eventually be argued that the accumulation of capital does not happen overnight and therefore that the financial unrest generated by the fall of the Lehman Brothers and which ended up dictating the sudden stop of lending from the EZ “core” – such as Germany, Netherlands, France, Belgium and Austria – to the GIPS, undermined the sustainability of running such current account deficits. However, even disregarding what can be done in a decade, not only there were no signs suggesting that a reversal of the trade imbalances within the Euro area were to come, has there were several suggesting a further deepening of those. During the same decade, while consumption generally increased across sectors in the southern economies, there was a reallocation of resources towards the non-traded sectors at the expense of traded goods sectors. Rather intuitively, it would not have been through an increase in the production of non-traded goods that the net investment position of those economies relative to their northern counterparts would be reversed. Hence, it is of interest to address the question of whether this “misallocation” was due to GIPS economies’ inherent characteristics that lead them to underperform or whether it is the result of structural fundamentals.

With international competition, the price of similar tradable goods in different countries tend to converge over time. The existence of gaps between such prices implies that it would be profitable to buy the good where it is quoted at a lower price and sell it where its price is higher. Being these arbitrage opportunities fully exploited, the price gaps will be eliminated. Although there are several factors that make postponing the materialization of such arbitrage movements – as the need of establishing contact networks in retail sectors – and others which imply permanent gaps even with the fully materialization of these movements – such as the existence of tariffs or transporting costs –, in the liberalized and highly integrated Euro zone market these are not so relevant or even nonexistent. Thus, the increase in total absorption induced by enhanced credit availability from abroad does not affect the price of traded goods in borrowing economies whose dimension is not enough to influence the price fixed in the international market. In contrast, since a higher domestic demand can only be met by domestic production in some specific sectors, that same increase in aggregate demand will lead to a higher price of nontraded goods.

As a result, capital inflows will entail an increase in the relative price of nontraded goods that, in turn, by inducing entrepreneurs to move away from the traded good sector to the nontraded sector where the price increase provides relatively higher returns, creates pressure for nominal wages to increase which then deteriorate the competitiveness of the resident exporters, as the real exchange rate[1] appreciates.

Therefore, even with a friction-less labour market where workers can move across industries without any cost, the surge of capital inflows will lead to a reallocation of resources across sectors not conformable with the sustainability of current account deficits. Employment and output in sectors such as services and building and construction would increase while reducing in manufactures, which indeed was verified in countries like Portugal.

The possible escapes to such an effect, only distinguishable from the Dutch disease case in its source, are significantly restricted in the context of a monetary union. Without the possibility of resorting to a nominal exchange rate depreciation to mitigate the process of deindustrialization the only avenue to avoid a real exchange rate appreciation would be to have an increase in productivity in the traded goods sector relatively to what is experienced in the EZ partners. This productivity boost would make firms in the traded sector to demand more labour at higher wage rates thus avoiding the reallocation of labour away from this sector even with the increase in the relative price of nontraded goods.

However, given that in most sectors productivity increases are mainly driven by learning by doing and other factors that fall outside of the range of tools economic authorities have at their disposal, the traded-and-nontraded goods framework suggests that significant and increasing external imbalances within a monetary union constituted by economies which differ in productivity levels across the traded sectors are unavoidable. Hence, the sustainability of such current account deficits relies crucially on the capability of preserving the capital flows between creditor and debtor economies.


[1] The exchange rate referred to is defined as eP*/P , where P* and P are the consumer price index of abroad and of the home economy, respectively, and where e is the nominal exchange rate defined in a way that an increase means a depreciation.




Baldwin, R., & Giavazzi, F. (2015). Rebooting the Eurozone: Step I – agreeing a crisis narrative. CEPR Policy Insights.

Benigno, G., & Fornaro, L. (2013). The financial resource curse. London School of Economics.

Reis, R. (2013, August). The Portuguese Slump and Crash and the Euro Crisis. NBER Working Paper.


Francisco Rodrigues nº 31154


Sudden stops and the Eurozone sovereign debt crisis

The Eurozone sovereign debt crisis has been one of the most difficult tests to the cohesion of the European Union and to the euro. Over indebtedness and financing constraints on both governments and banking sectors spelled disaster – leading to massive unemployment rates and permanent output reductions in the periphery countries: Greece, Portugal, Ireland, Spain and Cyprus. This paper briefly explores the dynamics of the balance of payments and focuses on the loss of access to international financing experienced by these countries, i.e. the sudden stop, and its impact. Furthermore, it analyses how foreign currency reserves could be used to maintain current account deficits after a sudden stop in a country that issues its own currency and how that is typically unfeasible; why the euro monetary union reinforces this unfeasibility for its members and how, at the same time, it created a mechanism to deal with the reversal in the direction of capital flows within the Eurozone: TARGET2.

The current account measures the net lending position of an economy, that is, the difference between domestic savings and investment. Together with the capital account they make up the two components of the balance of payments. The balance of payments is, by definition, equal to 0 – therefore, a current account deficit must be compensated by an equal capital account[1] surplus. In other words, if the economy chooses to run a current account deficit then it necessarily needs to be financed by foreign capital inflows. In practice however, these do not always match. When the capital inflows are larger than the current account deficit the excess capital builds up as currency reserves. But what happens when the capital stops flowing?

To get to the key concept of this paper and following the tradition in literature I will quote the banker’s adage that coined the term: “It is not speed that kills, it is the sudden stop.” A sudden stop is an abrupt decrease in net capital inflows to an economy and typically happens when, after a series of current account deficits that create over indebtedness, there is a blow to confidence. It can be triggered by foreign investors who halt their capital inflows to the economy, or by domestic investors who pull their money out of it. The heart of the problem is that when investors lose confidence and the nation loses access to international financing it becomes unable to roll-over its debt and, consequently, is forced to close the current account deficit. That is the same as saying that the economy cannot keep the same levels of consumption and investment, it must reduce both, which decreases aggregate demand and throws it into a recession. In the context of the two-period investment economy, international financing allowed agents to first take the investment decision that maximizes their lifetime wealth and then lend or borrow in order to smooth consumption patterns. In other words, agents were able to separate their consumption and investment decisions. When the economy loses access to international financing it loses this separation property – the investment and consumption decisions become a single decision. If agents wish to invest today in order to consume more tomorrow, they must consume less today. This creates permanent reductions in lifetime wealth and standards of living because agents are financially constrained and unable to set the investment level that maximizes it, given that they have present consumption needs.

If a sudden stop occurs, the currency reserves could be used to finance the current account deficits. The central bank of a country that issues its own currency could make foreign currency available to the economy, thus allowing agents to borrow, pay for imports and in the future pay back. One can think of it as artificial international financing. This preserves the separation of consumption and investment decisions and maximizes wealth. However, in practice, the currency reserves are not enough for this purpose because most of them are used by the central bank to protect the domestic currency. It is essential that the central bank do so because sudden stops are usually accompanied by capital flight. That is, not only do investors stop pouring capital into a distressed economy, they also withdraw their capital. Which inexorably leads to currency devaluation and could escalate into a currency crisis. In this scenario firms of the affected nation are in trouble because their revenues are typically denominated in the domestic currency, but their debt is in foreign currency. They may easily become insolvent and tip the economy into a recession. Therefore, foreign currency reserves are typically unable to keep an economy afloat during a sudden stop episode because they are quickly depleted by central banks’ efforts to maintain the value of the domestic currency.

The Eurozone, by creating the single currency, has made it even harder for a member economy to finance a current account deficit with central bank foreign assets. Note that the main trading partners of Eurozone members are precisely other Eurozone members, thus their current account imbalances are, for the most part, vis-à-vis one another. Further they share the same currency, which means the “foreign” currency with which they run their deficits is not foreign at all – it is domestic – and it is not an asset of the national central banks, it is a liability – and as such cannot be extended to the economy. Therefore, the current account deficits observed in the periphery economies could not possibly be financed by currency reserves.

The European periphery countries experienced massive inflows of private capital during the period of 2002 to 2007-09. Followed by a sudden stop episode[2] alongside capital flight. One would expect current account deficits to be reversed but the fact is that there was only a slight adjustment. What happened then? Private capital outflows were compensated for by an equally sizeable rise in public capital inflows. The bailout programmes were an important channel of these inflows but there was yet another channel that was crucial in its own right: the Eurosystem and its payments system, which by financing current account deficits through the creation of Intra-Eurosystem liabilities for the national central banks of periphery countries succeeded in mitigating the negative impact of the sudden stop. To see why let us look at what happens to banks’ balance sheets during capital flight.

European commercial banks are legally required to keep reserve accounts with their national central banks. TARGET2 settles international payments within the Eurozone by applying debits and credits to these accounts. In the event of capital flight, agents withdraw their deposits from the banks in the distressed countries – in this example, Portugal. This necessarily leads to an equal reduction in the reserve account at the commercial and central banks. Naturally, the opposite happens on the country receiving the capital. Now, if this was the whole story, then we can see that net capital positions at both national central banks would change; which would impact net profits. To solve this problem the system provides national central banks with credits and debits in the form of a bilateral position vis-à-vis the ECB, recorded in the balance sheets as “Intra-Eurosystem Assets” (IEA) and “Intra-Eurosystem Liabilities” (IEL). These liabilities are essentially liquidity extended by the ECB to the banking systems of the distressed countries, and, I reiterate, are what compensated for the private capital outflows thus allowing these economies to maintain, to a large extent, their current account imbalances. Other sources of public capital like the bailout programmes also helped of course. However, had this mechanism not been in place, the recessions experienced by the periphery could have been much more severe and led to even greater losses of output and wealth.

Banks' BS

Figure 1: Capital flight impact on banks’ balance sheets


Nuno André Nóbrega, 3714




Merler, Silvia; Pisani-Ferry, Jean (2012): Sudden stops in the Euro area, Bruegel Policy Contribution, No. 2012/06

Whelan, Karl (2012): TARGET2 and central bank balance sheets

 Mody and Bornhorst (2012): TARGET imbalances: financing the capital-account reversal in Europe




[1] Here defining: BOP = current account + capital account.

[2] Merler, Silvia; Pisani-Ferry, Jean (2012) identifies three sudden stop episodes but for the purpose of this article it is enough to group them in one episode.

The Good, the Bad and the Ugly

Back in the 60’s, people were thrilling on breathtaking long eye-contact Mexican standoffs. That was the time when no one could visualize the upshot of the good, the bad and the ugly confrontation. A long time passed since one of the greatest Westerns of all times and a more obvious clash of multiple equilibria arose to fulfill the gap that separated the younger generations from those tremendous duels.

In this article, I want to assess the effect of the mass media on determining the outcome on a multiple equilibria framework looking at historical data on stock pricing, financial bubbles and then linking the results to two clear situations where perceptions played a central role defining the outcome.

The motivation for this article departs from Robert Shiller’s statement relating the appearance of the first bubbles with the advent of the newspapers. Furthermore, “Significant market events generally occur only if there is similar thinking among large groups of people, and the news media are essential vehicles for the spread of ideas.” (Shiller, 2015, p.101). One striking example in Portugal was the Banif-TVI case. Despite the unknown expected instability of Banif, it was the news from TVI that triggered the deposit run (Público, 2017). Hence, I will conduct a simple assessment on the influence of the media in guiding towards a particular equilibrium.

The role of the media building expectations

The influence of the media in investors prospects is more widely known when discussing stock prices. Hiroyuki Aman (2013) tested two hypotheses for Japan in this field: a) the mass media is a contribution towards the increase of the basic level of information, meaning their reports should smooth the pricing process and reduce crash frequency; b) the mass media leads to more frequent and large reactions among investors, being harmful to smooth pricing. Evidence is provided on the latter, crash-inducing effect, but a not significant effect on jump-inducing effects.

Would the previous results hold for other occurrences in the financial markets?

Taking a step-closer to the debt crisis, the RR-PP model establishes a situation where three equilibria can take place: a good equilibrium, a bad one and the ugly (debt crisis). The model relates the probability of repayment with the interest rate, given that the investors conjecture a given probability of repayment given a value of the interest rate (RR curve), but the lower the probability of repayment the higher the investors demand to hold debt (PP curve). The important part of this model I want to highlight is the fact that coordination would make possible to move from a bad equilibrium to a good equilibrium. Actually, this hypothesis is put forward in the case of a country owned by one individual creditor. After this 500 words breathtaking long eye-contact, the argument that could solve the standoff is the mass media coverage as a coordination device.

Nevertheless, research has been conducted mostly on the pervasive effects of media. Wisniewski and Lambe (2013) measure the effect of negative journalistic opinions in the abrupt falls in the market value of equity in the banking sector. Figure 1 depicts their initial analysis where they choose three keywords (“credit crunch”, “financial crisis” and “bank failures”) as proxy for negative news on the topic.

F1 23768

Despite the Canadian case where they were able to reverse the situation, the authors verified that the accumulated response to the increasing number of news worsened the sharp fall in value.

So, one can argue that the media play a role, even though the studies and regressions can shortfall in generalization and causality is difficult to be addressed. The next step is to infer how can it be used for to achieve Pareto superior outcomes.

The Good Mario Draghi

The first scenario I will provide is the self-fulfilling crisis in Europe. At the time, rating agencies, mass media, public opinion makers were pressing the less sustainable countries towards successively higher bond yields. In light of the RR-PM model, this translated into a shift from a good equilibrium towards a bad equilibrium. The 2012 Outright Monetary Transactions announcement reversed those pressures and was successful to change investors feelings. Take notice that until 2014 no country requested intervention by the ECB under OMT (Miller and Zhang, 2014), but the effects had clear effects on Spanish and Italian bonds, two of the countries that had increasing burdens (figure 2). Here I postulate the role of news in the transition towards a better outcome. A self-fulfilling crisis can be stopped by an act of belief (Calvo, 1988) and mass media constitute the bigger influence in this field. The introduction of forward guidance practices by the ECB, in 2013, acknowledges the relevance of managing expectations.

F2 23768

The Ugly Greece

By the other hand, other countries faced a tremendous and focused narrative of bad conjectures. Greece was the most severe case of a country that, opposing the solutions presented, was the most affected by negative news. Following Tracy (2012) conclusions, Greek financial crisis was reduced to the alleged shortcomings of a nation and its people. Greece was pushed successively towards a bad equilibrium and further towards a debt crisis. A lot can be to blame to poor country stability and debt control, but as Wisniewski and Lambe (2013) pointed out in their example, the media may have aggravated the situation. Back in those days, and as the competition between newspapers intensifies partially to the successive reduction in media revenues, the eager instinct of journalists to have the best news with the most eye-catching headlines has increased. Greece, with all its fierce opposition to the widely advocated solutions, became an easy target.

The Bad dies after all

The influence of the media in a multiple equilibria context is not easily assessed and the research provided until now give good hints, but a lack of formal proof remains. With this article, I wanted to highlight that the media have a role as coordination device in self-fulfilling crisis, and historical examples give evidence on that. That end of the breathtaking long eye-contact Mexican standoffs can be nudged, the world may increase its robustness to shocks when understanding how to not make life harder during a crisis and actually improve the prospects just by aligning people’s expectations. At last, the use of a simple RR-PP model and various empirical evidences on the effect of news in investors prospects has created a path towards achieving that objective, so that the bad can die after all.

João Matias | 23768  | Master in Economics 2017/2018

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Why Luanda is the most expensive city in the world?

Why Luanda is the most expensive city in the world?

Since 2002, Angola has been growing at an interesting pace, the country´s natural resources endowment is outstanding, namely oil. Yet when the global oil price has negative swings, Angola economy becomes vulnerable, which happen in 2014. Broadly speaking, when a state is very exposure at one specific industry, more usual, one specific commodity, this creates a problem which it is called Dutch Dieses. So, I will try to explain how this event increase the relative price of non-tradable goods and make Luanda the most expensive city in the world according to Mercer’s annual “cost of living” ranking.

                How to have a wealthy country in natural resources could be a diesis? First of all, I will try to show how labor and production will change during the “boom phase”. Typically, when a commodity becomes extravagant pricey, the countries producers gain with this event. So, this make the suppliers richer and creates an expansion of domestic demand, by arbitrage conditions the price of traded goods does not change, to do so, the relative price of non-tradable sector (Pn/Pt) need to increase, in order to respond for this excess demand. When I made this analysis, I am assuming fixed exchange rate, which is a realistic assumption because Kwanza at the “boom phase” had a peg with dollar.

Consequently, these movements of prices come along with a boost in nominal wages, which create a raise in real wages in traded sector (w/pt). Another important feature it is regard to the domestic absorption, which also increase. These two effects (which could be call substitution and income effect) made firms in these industries (exporting firms, except oil producers) reduced production in order to survive to international competition. Hence, labor shifts to the non-tradable side of the economy; a good example of this side is the building construction or services companies. In theory if I assumed flexible prices, which is a reasonable assumption in this phase because the adjustment is slow, the overall economy is in full employment.

 Empirically, it is difficult to stated that a country as in full employment, usual when a country stays in 5% unemployment rate you can said that with confidence, but some countries have several socioeconomic environments which become hard to achieve such a truth statement. This applied to Angola, a country with a deep inequality between capitalist and workers. Another important feature which turn this analysis much more complex, it is that a considerable number of immigrants arrived at Luanda at this “boom phase”. So, the numbers of unemployment rates were ambiguous, but we could have looked at growth rates and concluded that Angola was booming.

In other words, this inflation on the endowment of Angola, between 2002 and 2014, creates a real exchange rate appreciation, which does not come along with an increase in productivity of the all traded sector, such as Blassa-Samuelson preposition. Therefore, Luanda saw the house prices hike in a way very dangerous for society, but in theory in full employment. Additionally, when the price of houses increases in that way create an illusion, because normally banks ask for houses or buildings as a collateral, so, in this time households and government does not face borrowing constraints. Moreover, the inflows of skilled immigration help to this bubble in house market.

However, when price of oil falls they could face a lot of limitations, which I will try to show how this happen for Angolans. In 2014 global oil price fall a brutally, which made Bank of Angola lose your peg and your growth to decline a lot. Now, this wealth, if it is not used in a sustainably way, looks more as a dieses. Currently, oil producers need to have diversified economies and other stabilizations tools, such as wealth funds like in Norway, to gain with past revenues and do not have currency or others crisis in the future, alike in Angola. Emerging markets have been restricting capital movements in order to mitigate this immersing growth, but it seems a good solution in short run, however, I strongly believe in that countries in the long run will always want to enter in the global world, so, this do not solve the headache of huge capital inflows just delay the problem.    

 Despite the fact that they do not hold a huge external imbalance as Portugal or Greece. They, also, suffer with credit limitations, so, financial market, now; do not play the role of smooth consumption like in theory. Regarding this, Angolans saw your domestic absorption declined and workers needed to adjust rapidly to the tradable sector. In reality, these adjustments are very difficult to achieved, because the price fall a brutally as I mentioned before, and adjustment needed to be almost instantaneous for economy still function in full employment. However, market frictions could complicate the process.

First complication is regard to skills and geographical mismatch, a worker in services probably does not know how to do manufacture or do not hold the mobility needed. Secondly, labor market regulations as syndicates which prefer higher wages and fewer workers in your industry, bureaucratic procedures or because it takes time to redefine a business. These innumerous examples of possible explanations for delays for the adjustment needed show how the real exchange appreciation before putted Angola out of full employment, when the price of oil declined.

Nonetheless, this environment has different redistributive effects, which are more aggravated for a country unequal as Angola. Owner of capital will prefer wage flexibility in light of higher profits and workers will be dividing in two groups. Those which are employed and those which are unemployed, in one hand, price stickiness would reveal higher wages, on the other hand, flexible wages put economy in full employment. Additionally, Angola have a suspicious democracy, so, more controversial was the choices implemented, in respect of legitimacy.   

All in all, it is hard to adjust at once, to that end how to mitigate this exposure? Since 2014 become clear that oil producers will not hold the same power as previous years, for example as oil shocks in 70´s or 80´s. Developments in others energies less scarce and more friendly to world gain a lot of space nowadays. Several countries created laws in light of others renewable energies to earn more market power. Consequently, how oil producers, namely Angola, gain with them remain wealth and invest smartly in your future?

Now, it is time to construct incentives to shareholder and others economic agents to persecute others business with modern technologies and become competitive. Although, if they want to continue in energy market need to adapt. For example, as use of hybrid and electric cars grows, the transportation sector will rely increasingly on the electricity sector or from renewables, such as solar and wind. Others helpful policies could be real devaluation by nominal exchange rate or by fiscal (devalue) reforms.



From several years, the central banks of major economies (US, Eurozone and Japan) as well as others, are implementing expansionary monetary policies. The money supply has increased enormously: in the United States, in early 2016, was four times that of 2008. The ECB, after a period of purchase of covered bond financing at low cost the banking system, in a dramatic change of policy, announced on 22 January 2015 by Mario Draghi, its President, implemented an ‘expanded asset purchase programme’ (quantitative easing): where €60 billion (then 80 million) per month of euro-area bonds from central governments, agencies and European institutions would be bought.

It has been an injection of unprecedented liquidity, which has driven down interest rates in the short and long term close to zero (and, in some cases, negative, as in Japan or Europe). This was supposed to stimulate investment and, therefore, consumption and income. The results are, however, well below expectations. In the Eurozone, the data on GDP and inflation show, in fact, as the recovery is very weak. Even in the US, where growth is higher than that of Europe, GDP remains below the potential.

Given the stagnation of aggregate demand, the liquidity provided by central banks has been poured on the financial markets. In the Eurozone, the banks that have liquidity obtained at very low cost by the ECB have massively bought government bonds. The rates have declined, with beneficial effects on public finances, while asset prices, including those of shares and corporate bonds, have increased considerably. Monetary policy did not, however, the desired effect on the real economy.

In 2013, to explain the US economy recession after the subprime mortgage crisis, Larry Summers, he revived the theory of “Secular stagnation”.

2. The theory of Secular Stagnation

This theory was advanced by Alvin Hansen in 1938, back when the world was shaken by the Great Depression, to describe what he feared was the fate of the American economy following the Great Depression of the early 1930s. Hansen suggested that the crisis of the ’30s had started a new era for the economies. An era of ephemeral economic recoveries, lasting recessions, rising underemployment: a secular stagnation, precisely where the term secular was used in contrast to cyclical or short-term, and evoked a change of fundamental dynamics which would play out only in its own time. According to Hansen, the base of stagnation had three main causes: geographic expansion of territorial expansion that characterized the nineteenth century; the decline in the population growth rate; the use of new technologies to less capital intensive than those used in the early stages of capitalist development. By reducing the need of investments, those forces would drive the economy into a low growth and high unemployment equilibrium. Hansen considered the crisis of the 30s and its length as the result of the gradual weakening of the impetus for growth in the US economy and the isolationism and non-interventionism policies adopted in the 1930s by the US Congress through the Neutrality Act.

It is singular that the II world war, broke out in 1939, changing the conditions of Hansen theory: enabling the “growth miracles” of the 50s and 60s. and consolidating the US political and economic superpower. It also remarkable that the theory of secular stagnation was reintroduce when new economic and political superpowers, as China, emerged in the world scenario weakening the US supremacy.

As mentioned before the “new secular stagnation hypothesis” recalled by Larry Summers in his now famous speech at the IMF in 2013, and then developed by further contributions, to explain the trend of persistently sluggish economic growth in much of the industrialized world. The Summers hypothesis is that aggregate demand has declined (though well before the global crisis, although then it was masked by unsustainable financial conditions) due to shocks that simultaneously induced an increase in the propensity to save and a decrease of that to invest. Under normal circumstances, according to Summers, interest rates fall (due to market adjustments, or of specific policy interventions) until equality between savings and investment is not restored to the level consistent with full employment of resources. However, this adjustment process tends to be stuck when the natural in rates approach the zero lower bound. In other words, the Great Recession that began in 2007 had to be considered the culmination of a period in which the public and private debt, and an abnormal financial development, supported the growth compensating for the chronic lack of aggregate demand. The decline of the natural rate of interest and the real one would be the acute symptom of stagnation of demand, excess savings compared to investment.

Paul Krugmann too agrees with the analysis of Summers, but, unlike the latter, his analysis adopted an approach based on the logic of the liquidity trap. This approach reflects the circumstances in which parties form pessimistic expectations about the future path of income and savings levels are pursuing more than the economy is unable to absorb, thereby causing a fall in the natural rate of interest in negative values. In these circumstances, as nominal interest rates are constrained by the lower bound of zero, the economy falls into a liquidity trap, where conventional monetary policy tools lose effect and the injection of base money into the system does not affect the expenditure: currency and bonds are seen by the private sector as perfect substitutes and no open market operation, in significant numbers, can bring the economy back to full employment.

3. Escape routes from secular stagnation

In industrialized economies combine adequate growth, utilization of productive capacity and financial stability has become increasingly difficult, even because they are other headwinds of the growth. The decline in the population growth rate and the aging that reflect negatively on the demand for investment and consumption. Slowdown of technological development, which implies a reduction in demand for capital goods in order to create new employees. The lowest level of prices of capital goods, which implies that any given level of savings can get more amount of capital than was possible before. The growing inequality and poverty and the consequent decline of the national income share relating to individuals with higher propensity to spend. Major frictions in the financial intermediation sector as well as the increased uncertainty and risk aversion generated by the crisis.

Given the complexity of the causes that determine the secular stagnation the same Summers advised against the path of negative rates, even if that it is proved as feasible, for the negative consequences that would have for financial stability of the system. For this reason, he recommended of policy strategies geared towards enhancing the natural rate of interest by increasing public investment, the reduction of barriers to private sector investment, and the implementation of measures to promote confidence, the maintenance of purchasing power and the redistribution of income to categories of operators with high propensity to spend.

According to Krugman instead the central banks should increase the money supply so that the prices can raise and, the real interest rate can be put down until it matches the natural rate of interest. The determination of the central banks to generate inflation should be strong enough even publicly promising to behave credibly in irresponsible way. But because the commitment to behave irresponsibly has no effect is the public does not believe in the increase of inflation, the same Krugmann is forced to conclude that the only way to increase inflation is to accompany the non-conventional monetary policies with strong fiscal stimulus and public expenditures.

This approach has however important implications for the eurozone. Here GDP is now 15 percent lower than the potential level of 2008 and, although the worst of the crisis appears to be behind us, the Member States worst affected by the recession are still grappling with inflation too low and growth too weak. The ECB has so far pumped billions of euro into the national banking system through quantitative easing program (QE), but little of that money has so far resulted in credits to the economy on more favourable terms. Of course, the money pumped lowered spreads on riskier government bonds, giving a bit ‘of breath to national finances contracted until its last legs, and provided oxygen to export industries through the weakening of the euro. But this is not enough and the effects may not be lasting and sufficient. And it is not easy reconcile economic recovery with the European fiscal rules and especially with the Fiscal Compact.


Summers, L (2014), “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound”, Business Economics 49(2)

Gayatri Fresa


Japan Bubble and “The Lost Decade”: Monetary policy in a trap.

December 2017


The pur pose of this article is to show how Japanese economy had a perio d of stagnation after a recession in 1989 and how the methodology to c ounter the crisis is the same which is applied in Europe during last few years. The period was characterized by a phenomenon called liquidity trap which occurred in the first Great Depress ion and in Ja pan after the burst of the real estate market bubble. The aim of the research is to link the material studied in class with th e economic situation s that really happened.


The liquidity trap is a n extremely rare phenomenon which only occurred very few t imes in history . The best – known case is the Great Depression . Everyone know s what happened in the USA during the late 2 0s where for the first time a new phenomenon was discovered by John Maynard Keynes : t he inefficiency of monetary policy during situations in which interest rates are low and savings rates are high. The American case was the only time this has happened until the Japan ese depression in the 90s which occurred after the real estate and stock m arket bubble. Before th at , no other case was ever identified and for this reason someone defined the Great Depression as an isolated event. However, this was not the case . During the last 3 0 years, the Japanese economy struggled even if it experienced strong private sector growth during the 1980s and in the early 1990s . Only since late 2013 we have seen a noticeable changi ng trend in the economy of the oriental island. Before the huge crisis, experts believed that Japan could be a successor of the USA a s the world ’s major driving force thanks to the exponential growth that characterized the entire post – war period. However, the engine power of the Japanese economy was essentially policy based . Bi g companies and the Government conducted long – term investments in order to reduce the gap with the USA . Unfortunately , a t the end of 80s , the Japanese business cycle g o t into a negative phase that still has influence in the economy today . We can find one similarity between the Great De pression, the Japanese crisis and what has happened in Europe some years ago : all the scenarios where forerun by a huge real estate bubble. During the Great depression, the real estate bubble was caused by an easy access to credit and by overvaluation of property . T he same happened with the subprime mortgage a decade ago . These causes added up an extremely fast rising price and an elevated aggregate demand growth in Japan had the same effect causing a deep economy drop . Furthermore, overconfidence and the Bank of Japan’s loose monetary policy in the mid – to – late 1980s led to aggressive speculation in domestic stocks and real estate, pushing the prices of these assets to previously unimaginable levels . The peak was reached when the total value of lan d in Japan was over four times the real estate value of the entire United States.

The absolute peak was reached in 1989 when the Nikkei 225 index was at more than 38.500,00 points . Nowadays, in 2017 the same index has 30% fewer points than so many years ago.

When the huge speculative bubble blew up, economic growth in Japan slowed down remarkably . Labour productivity decreased noticeably and the Japanese economy stumbled into 20 years of stagnation. During the two – year period ‘91 – 92, all important economic variables started to drop . GDP growth fell from 6% of the previous years to less than 1,5%. Unemployment strongly and constantly increased while inflation decreased year over yea r ; a long period of deflation and stagnation started.

The “ Lost Decade” is how expert s called th is period of time in Japan during the crisis . It has been one of the most studied economic case s with the goal to learn from past experiences and try to do not repeat the errors committed by Japanese fiscal authorities. Unfortunately, we all know what happened in 2007 with the subprime mortgages and in 2011 in Europe with the sovereign debt crises.

The Japanese GDP slowed down strongly until 1995 and during the two – years period between 2001 and 2002 the economic performance seemed to be one of the worst compared to Europe and the USA. The decrease of gross investments linked with private consumption pushed Japanese unemployment close to 5%. However, t he most important factor seemed the CPI. I n Europe and in the USA the CPI was close to 2% but in Japan the rate was zero or even negative in the same period of time since 1994 . The short – term interest rate became zero in response. T he nominal interest rate usually cannot be negative , however. T his situation was an indicator of the liquidity trap.

The Japanese Fiscal Authority underestimate d the crisis ’ seriousness for a long time . Initially, the authority was too shy and only since 1998 the G overnment decided to increase the expansion. Unfortunately, it was too late.

The problem reached huge dimensions because the Japanese sovereign debt was already too high. According to the Ricardian equivalence mechanism , in a rational scenario, forward – looking taxpayers will anticipate paying for government spending at some time in the future. If the government defers taxation, tax payers will save part of their income to pay higher taxes in the future in order to meet the bond obligations. This higher saving causes private demand to decline when government demand rises which reduces, if not totally eliminates, the demand stimulus created by higher government spending. During a period of liquidity trap, the expansion of the monetary policy made b y the BOJ had no effect because the demand of money is infinitely elastic to the interest rate . A fiscal expansion might have been really efficient . When the gross interest rate is zero, it is impossible to go below that value . In that case we are in a liquidity trap situation which is what happen ed in Japan.

Furthermore, the decisional process of the Central Banks in order to fix the short – term interest rate can be described with the Taylor Rule:

Screen Shot 2017-12-05 at 17.18.19


• 𝑖𝑡 𝑡: : short term interest rate

• (Alfa) 1 : weight of the inflation target

• (Alfa) 2 : weight of output gap

• ρ : non – smoothing willingness of interest rate .

When we have to f aceoff a deflation period ( π < 0) even the output ga p is negative because we have a recession period . Indeed, when 𝑖𝑡 𝑡− − 1 is already equal to zero, the Taylor rule need s to set 𝑖𝑡 𝑡 lower than zero . U sually this is (was) not possible but we have witnessed some years of negative interest rate s in Europe and Japan (this is an unconvention al monetary policy also called NIRP, the results are a collapse in the aggregate demand and an increase of unemployment) . For this reason, the output gap became even more negative and the decrease in prices became stronger causing an instable deflationary spiral. In our case, this is exactly what happen ed in Japan during the last twenty years.

The BOJ tried to counter deflation with Quantitative Easing during 2001. In 2013 , the BOJ conducted Quantitative and Qualitative Easing by increasing the purchase of sovereign bonds with the goal to bring inflation to a level of 2%, as quickly as possible. The QE in Japan has been applied until some month s ago and seemed to have produced effects only at the end of 2015 whe n Europe with Mario Draghi started to address the crisis in the Euro zone with the same policy. Nowadays, there is a fear that QE could generate the same story line as in Japan for more than a decade in Europe. Can we assert that the Jap anese QQE was an evident failure ? Or has it been the only way to emerge from a negative business cycle? All we know for sure is that it is the way taken by Europe for the next years.

Giovanni Accardo
31219 – 3722
Macroeconomic Analysis Essay


Akram, Tanweer. 2016. Japan’s Liquidity Trap.

Levy Economics Institute.

Bongini, Ferri, Patarnello. 2014. “La Crisi Giapponese: scenari macroeconomici e ruolo del sistema bancario.” (Giovanni Ferri) 1 (1).

Cova, Ferrero. 2015. “Questioni di Economia e Finanza : Il programma di acquisto di attività finanziarie per fini di politica monetaria dell’Eurosistema.”

(Banca D’Italia) 207 (1).

Krugman. 2013. “The Japan Story.” (Paul Krugman).

Krugman, Paul. 2000. Krugman on the Liquidity Trap: Why Inflation Won’t Bring Recovery in Japan.

Levy Economics Institute Working Paper.

Sgroi, Maurizio. 2016. “Vent’anni di QE e tassi a zero non bastano al Giappone.

Perchè dovrebbero curare noi?” (Il Sole 24 Ore).

The Liquidity Trap – History & Theory

History & Theoretical Concept

The liquidity trap is a state of macroeconomics inherent to (Neo-) Keynesian economic theory. Put simply: the term ”liquidity trap” refers to a situation in which nominal interest rates are so low that stimulating the economy through monetary policy is impossible. To understand the liquidity trap it is important to understand under what circumstances Keynes and Hicks developed the idea.

Keynes developed his theories and models in the light of the Great Depression in 1929 and subsequent years which certainly influenced his perception of the then prevailing state of macroeconomics and led to the publishing of his work the General Theory in 1936. The idea of the liquidity trap gained more substance through the summaries of Keynes’ fairly unapproachable theories through Hicks in the following year (1). The IS-LM model brings together the markets for money and for goods and – opposed to the classical models – focuses on the short-run instead of the long-run (”In the long-run, we’re all dead!”). Keynes’ changes in money demand and the assumption of sticky prices allowed for monetary policies to influence demand. Thus, by increasing nominal money supply (for simplicity reasons it is usually assumed that this is only done by the central bank) real money supply increases as well and expand consumption and investment in an economy. If now, given the excess money, the demand for bonds and consequently their prices increase as the nominal interest rate declines. This effect though was nowhere to be seen during the Great Depression in the United States.

Hicks argued to recognize a positive price floor to the short-run interest rate and that the long-run rate is based on regressive expectations about the future value. His reasoning was that nominal interest rates would never cross the threshold of zero interest rate as otherwise holding money would strictly dominate bonds as an asset (2). This leads to the money demand curve to be almost horizontal on its right side.
If now, the nominal interest rate reaches a level close to zero this would imply that the demand for money becomes infinitely elastic and hence monetary policy to boost demand ineffective. Assuming an economy in a depression (remember the context) this would mean that the economy is in a liquidity trap. Even with the interest rate being zero and thus bonds and money being equivalent assets monetary policy would remain ineffective.

An economy in a liquidity trap staying in recession for some time can experience deflation as a result. A persistent deflation will cause the real interest rate to rise which in return will disincentivize private investment through the high costs of borrowing. Therefore, output will further decrease with monetary policy still being ineffective. The economy finds itself in a vicious cycle.

There are two main solutions to a liquidity trap: Keynes suggests an increase of government spending to compensate the lack of private consumption and increase demand. Including the effect of the multiplier, the government will be able of driving the economy back to full-employment. A more monetarist approach suggests quantitative easing: the central bank provides liquidity to the economy by buying mostly long-term or toxic bonds or other securities with the purpose of lowering the interest rates

and thus making private investment feasible and attractive again (3). 

Real World Link

The 1930’s Great Depression in the United States is the most striking example of an economy in a liquidity trap. A second – universally not undisputed example – marks Japan in the 1990’s. The Japanese economy had suffered from recession and constant deflation since the early 90’s leading the Bank of Japan to decrease the interest rate continuously until reaching a zero interest rate in 1999. Further attempts of controlling for this phenomenon with quantitative easing as discussed above were undertaken since 2001.

It was widely agreed that Japan needed to induce private-sector expectations of higher future price levels and inflation in order to lower the real interest rate with nominal rate unchanged at 0%. The problem turned out to be that the attempts of quantitative easing were clearly considered as being temporary rather than permanent and thus failing to induce expectations about higher price levels (4). None of the attempts has been fruitful so far and as of 2016, Japan still remains in a liquidity trap. In order for Japan to restore the state of their economy fiscal policy to enhance productivity, real wage growth and international competitiveness need to support monetary policy actions. Furthermore, Japan depends on a more favourable global economic environment and financial conditions that can avoid expectations of declining long-term interest rates in many advanced economies (5).

(1) Blanchard, 2000: Macroeconomics. Massachusetts Institute of Technology, Prentice Hall International, Inc.
(2) Krugman, 1999: Thinking about the Liquidity Trap.
(3) Hiro Ito, Princeton University Press
(4) Svenson, 2006: Monetary Policy and Japan’s Liquidity Trap. Princeton University, Working Paper No. 126.
(5) Akram, 2016: Japan’s Liquidity Trap. Levy Economics Institute, Working Paper No. 862.

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Brexit: effects of the currency depreciation on the British Economy

On the 23rd of June 2016, the United Kingdom took everyone by surprise with the results of its referendum. Even though some doubt remained until the final results, no one could have predicted such scenario. The decision to leave the European Union by activating the Art. 50 of the treaty of Lisbon has immediately impacted the Britain’s economy with high uncertainties. In fact, the first effect came through the instant depreciation of the Pound. This decrease in the value of the currency was mainly due to the future expectations and doubts expressed by the markets about the economy. These uncertainties concerned mainly the future potential performance of the economy, the latter being expected to suffer a downturn following the leave of the European Union. The question is why does the beliefs of the market have turned to be negative? The reason is quite simple. In fact, leaving the European Union will be mainly accompanied with costs, whether they are from political or economic nature. However, the higher costs that economists expect to happen are firstly, and mostly, coming through the international side of the economy, with for instance higher barriers to trade resulting from the exit of the customs union.

Trade Balance dynamics

The depreciation of the Pound resulting from the referendum impacted greatly the dynamics of the UK’s economy through different channels. Firstly, let us focus on the international market of the economy composed by tradable goods. With the depreciation of the pound, the tradable goods have become more expensive relatively to the non-tradable ones. In fact, as the price of the former are “set” at the international level, the increase in the exchange rate has made the value of the imports more expensive – also leading to an imported inflation. On the other hand, the devaluation has, in a sense, made the Kingdom more “competitive”, increasing the value of its exports. As we can observe, this two variables have an impact in the tradable balance, the exports having a positive influence while the imports a negative one. It is however hard, and somehow still soon, to assess which one of the two forces has been greater and will impact the future equilibrium. In fact, these changes will mostly depend on the extent on how elastic the demands of both exports and imports are in the long-run (Marshall-Lerner condition). The only effect that has been observed yet is the J-Curve effect, explained by the low adjustment of consumers’ behaviour accompanied with some lags and frictions that occur because of bilateral contracts already set internationally. It seems however that the initial widening in the trade balance deficit has been timidly narrowing, mainly due to the good performance of UK’s partners in Europe, increasing therefore the demand in the export sector. Moreover, when analysing the terms of trade (price of exports divided by the price of imports), we can observe a decrease in the ratio, thus leading to an outflow of money. This added to the already decreased propensity to invest, due to uncertainties felt by agents, could dump even more the aggregate demand in the following periods.

Effects on the Labour Market

The decrease in the value of the currency has also impacted the labour market. In fact, as the pro-Brexit would claim, the referendum has been positive as it has already decreased the national unemployment rate. However, we must analyse the whole picture before taking quick conclusions. In fact, the devaluation has increased the labour force in the manufacturing sector of the economy (it is important to underline that the great majority of the pro-Brexit vote came from this group of the population) since the tradable sector has become more attractive following the devaluation of the currency. However, this has made the sector less “productive”. In fact, with the increase in the rate of employment, the productivity has marginally decreased. Both the change in the value of the currency and the latter aspect have made the wages of each individual decreased in real terms – both in the tradable and non-tradable sector –  leading to a lower purchasing power. Moreover, as previously mentioned, the relative increase in the price of tradable goods has imposed an increase in the United Kingdom’s inflation. The latter has overpassed the threshold of 3% in last October and is expected to increase in the following months according to the Bank of England’s forecasts. Besides, this increase in prices has already had some effects on the national economy as it seems to have decreased the household’s consumption spending. Overall, since the results of the referendum, the deceleration of the economic growth has been notable if compared with other EU countries (forecasts announce only 1.6% of growth for 2017).

The reaction of the BoE

The Bank of England (BoE) has announced in the previous weeks an increase in the base interest rate from 0.25% to 0.5%. This decision shows the prioritisation of the inflation issue over the decelerating growth that the UK currently seems to suffer. In fact, by increasing the base rates, the BoE directly targets inflation, as higher rates will influence consumers to decrease their spending, and therefore reducing the rise in prices through lower demand. This decision could, and probably will, dump the aggregate demand even more, leading to a higher downturn in the economy as this will also squeeze the households’ purchasing power. Besides, a higher base rate also tends to increase investment in normal times, an effect that could partially compensate the decrease in consumption in the aggregate demand. However, since the increase in the base rate has been anticipated by markets, the effects of this decision may not have the fully desirable effects on the investment component.  Guessing a rise in the rate base due to a higher inflation than predicted, the pound’s demand augmented and therefore increased its value, marginally reducing its depreciation. This slight appreciation has, on one hand, decreased the price of goods imported, but also dumped the positive effects that have been coming through the export component following the depreciation of the exchange rate.

As it can be noticed, the decision of the BoE has two sides of the same coin. In fact, inflation is one of the most fearful issue that an economy can suffer and fighting it should be prioritised. Yet, decreasing it comes with a price that may challenge the economy for the next following years.

Long-Term Uncertainties

As it can be currently observed, the massive downturn predicted by the pro-EU in the UK’s economy hasn’t happened yet. This can have several explanations. Firstly, it needs to be underlined that the depreciation of the currency and its costs are being applied to an economy that has remained the same. In fact, despite the results of the referendum, the UK will remain in the EU until 2019 and therefore caution must be taken when examining the effects of this leave-vote. As previously analysed, the short-run effects are not as strong as presumed by the pro-EU. There has been a widening in the trade balance deficit followed by a lately small recovery, accompanied by higher inflation. Additionally, the unemployment rate has decreased, but so did the households’ purchasing-power. The long-run effects, on the other hand, seem to be harder to forecast because of the remaining uncertainty. This will essentially depend on the outcome of the discussions between the UK and the EU. A tougher deal, and therefore a harder Brexit, will undoubtedly have a severe impact on the economy. But one result will be surely achieved, a decrease in overall welfare, both in the UK and in the EU. Moreover, as long as there will be ambiguity regarding the future of the United Kingdom, the real exchange rate of the latter will continue to fluctuate. Therefore, for the wellbeing of Europe’s economies, a consensus avoiding tough penalties should be soon achieved.

Mélanie Chaves





Secular Stagnation

The term secular stagnation was first used in the context of the historical moment of the Great Depression. It was coined by Alvin Hansen in a speech at the American Economic Association in 1938.

Secular stagnation refers to a persistent and large period of sub-pair economic growth. One of the main factors for this ongoing low growth is the mismatch between the levels of investment (which become too low) and the levels of savings (which become too high).

The factors that seemed to be at play for economic progress – as explained by Hansen at the time – were i) inventions, ii) the discovery and development of new territory and new resources, and iii) the growth of the population.

Since this period, this concept has emerged again in light of the aftermath of the financial crisis of 2008/2009 by Larry Summers due to the lack of accelerated growth after the crisis resolution. The state of the world at that moment showed an increasingly ageing population (with exceptions in the African continent), a lack of discoveries of new territory and resources, which both, in turn, put a big emphasizes on inventions.

Tracking down the moments of great technological progress, Gordon 2011, mentions the Industrial Revolution from 1700-1830, that lead to the steam engine and the railroads. Then, from the 1870-1900 the advances in electricity, internal combustion engine and running water. And the latest progress starting from the 1960s that include computers, mobile phones and the internet. However, he argues that this latest technological progress is less relevant for economic growth. As had already been discussed by Hansen in the 1930s, “… it is possible that capital-saving inventions may cause capital formation in many industries to lag behind the increase in output.”. Which can simply translate to growth on information technology making capital investment more efficient and therefore reducing the need for other kinds of investment spending.

Manny, including Krugman 2012, have disregarded Gordons’ idea of ‘least important technological advances for growth’, stating that the new era of technological revolution is just about to start. However, it seems careless not to consider the implications of where the current technological progress is taking us. More automatization and a clear intent on the replacement of human labour can lead as discussed by Acemoglu 2017 to decreases on employment and wages.

This years’ NBER conference on the Economics of Artificial Intelligence, highlighted some of the potential implications of this new form of technology and its potential effect on economic growth. Artificial intelligence (A.I.) can be defined as “the capability of a machine to imitate intelligent human behaviour” or “an agent’s ability to achieve goals in a wide range of environments.

Artificial Intelligence, sometimes regarded as a more advanced form of automation can have monumental changes for economic growth. According to Aghion and Jones, Artificial Intelligence can be used in the production of goods and services with a potential effect on economic growth and income shares. At the same time, Artificial Intelligence may influence the process to create new ideas and technologies by helping to solve complex problem. The model predicts a decline in the share of GDP associated with manufacturing or agriculture once they are automated; however, this decline is balanced by the increasing fraction of the economy that is automated over time. Moreover, considering that Artificial Intelligence is increasingly replacing people in generating ideas, ongoing automation could prevent the role of population growth in exponential growth. Finally, authors state the model can generate a prolonged period with high capital share and relatively low aggregate economic growth while automation keeps pushing ahead. Depending on the way Artificial Intelligence is introduced, economic growth may increase, either temporarily or permanently.

Potential solutions for secular stagnation have been suggested overtime, still there is a debate on what are the most effective measures.

Central government may try to influence economic growth by implementing fiscal and monetary policy tools. An expansionary fiscal policy may reduce national savings, raising neutral real interest rates; by increasing substantially the levels of output through government expenditure, growth can be stimulated. Monetary policies are also tools to stimulate growth and can be either conventional or unconventional. Higher levels of inflation would be accompanied by lower interest rate which to stimulate the economy by achieving full employment. Lower interest rates makes borrowing cheaper encouraging spending and investments; aggregate demand increases pushing for economic growth. In this specific situation, given high unemployment rate and low materials prices, public investment programs may increase and restore pre-crisis levels of output. Conventional measures were not able to address financial crisis of 2008/2009 and governments implemented unconventional monetary such as quantitative easing; proofs on effectiveness to restore equilibrium are needed.

Following this reasoning, it seems that all these propositions are problematic to solve secular stagnations and might not even be at play. It would be therefore interesting to consider the role of Artificial Intelligence for growth. Given that traditional measures have been shown to be ineffective in specific situation such as economic stagnation, technological achievements might start to play a role in economic growth. Considering that the potential of Artificial Intelligence are still unknown, it is of interest to consider them as a potential measure to face challenging economic eras. Artificial Intelligence driven by technological innovation may be a potential solution to stimulus boost economic growth. In particular, traditional paradigms of growth might be challenged and adapted, as well as the way issues and policies in itself are resolved.

Edson Embana 27176

The curious case of Portuguese sudden stop: housing market in the spotlight


The different economic phases that Portugal faced had relevant implication on the housing market, particularly through the credit channel and the impact of  households’ wealth on consumption. Therefore, a macroeconomic perspective may help understand the interaction between business cycle and house prices. Portugal today is regarded to be an example of economic resurgence and the real estate market is a clear sign of such revival. But what are the drivers that encouraged this dynamic?


The capital inflow curse

In 1990 the commitment of Portugal to join the Eurozone induced an output boom and a large current account deficit. Portugal at the time was a relatively wealth country, but the poorest among the others joining the Euro, and characterized by a relatively high level of unemployment. The expectation for an integrated credit market generated optimistic behaviors. Portugal – as other Southern European countries – was deemed from international creditors, while ECB strengthen anti-inflationary policy, borrowing rates decreased and the country experienced a large capital inflow. The latter came with a boom in consumption. Households reduced their savings and borrowed more in order to smooth consumption. The credit market was particular audacious when granting private loans and the balance sheet effect contributed to amplify the pro-cyclical business cycle. In fact, the real estate prices, before joining the euro zone, were relatively low, but they went through an inflationary path when the euro fever started spreading. The collaterals’ value expanded such that households could easily obtain more credit. In accordance with the Law of one Price, an excess demand in both tradable and non-tradable goods, led to a price expansion in non-tradable goods. Accordingly, wages in the in the non-tradable sector raised.

When the financial accelerator stopped working, the boom phase turned into a slump. The disappointment raised from the euro induced a decrease in the aggregate demand because firms reduced investments. Moreover, households decreased spending, since they faced a high level of debt. The result was a low growth rate, 1.1% on average over 2002-2007, far below the euro zone growth, and a consistent increase in unemployment rate from 4.4% in 2001 to 8.7% in 2007. In 2006, Oliver Blanchard – chief economist at the International Monetary Fund – was asked to assess the macroeconomic Portuguese status. He stressed that one of the main reason that lead the country to a subsequent downturn phase was a significant increase in households debt and a boom in consumption raising because of unrealistic expectation of default.


(Mis)allocation of resources

During the slump eve, the real exchange rate appreciated of almost 12%, and most of the variation is linked to the increase in prices of non-tradable sector. According to the Balassa-Samuelson effect, when nominal exchange rates are fixed – like in the Eurozone – the real exchange rate appreciation is due to an increase in productivity. This dynamic could have explained what drove to the Portuguese slump, if the economy had showed an income convergence among the Eurozone and an increase in productivity in the tradable sectors. Nonetheless, while the borrowing rate converged among countries in the Eurozone, a productivity growth gap arose. Growth in Euro area was more than twice in Portugal and while unemployment was falling in Europe, it was growing in Portugal. Blanchard first contribution to the Portuguese study case suggested that an intervention to push wages down, would have helped the economy to operate at its natural potential or at least to reduce the large unemployment rate. The process was supposed to be a painful one, but necessary to prevent a sudden stop to occur. After the financial crises his conviction was dismantled.

The contribution to the Portuguese economist, Ricardo Reis, seems to better analyze the future shock that the country faced, enlightening the repercussion on the housing market. His theory states that the illusion of the boom determined the reallocation of employment from the tradables to the non-tradables, but the flow was uneven among sectors. Community services, wholesale, retail trade registered an expansion, while construction and real estate deteriorated seem to expand rapidly and suddenly burst during the slump. According to Reis, the sectors growing relatively more during the slump were also the ones with the worst productivity.

The 2008 financial crises propagated in Portugal, like in other European countries, and the cost of capital clearly increased. The credit market become extremely tightened, despite the effort of the ECB and Banco de Portugal to inject funds. In order to face the liquidity shortage, a significant fiscal expansion arose. However, the growth rate turned negative in 2009. Moreover, Portugal faced a Euro crises just after the financial crises, such that the credit supply turned to be even more tightened. The two shocks combined induced the country to face a sudden stop. Sudden stops usually arise because of a rapid arrest in capital flow, forcing the countries to go from a large deficit in the external balance to a surplus, in order to repay the debt. However, Troika program for Portugal aimed to mitigate the sudden stop consequences through liquidity provision and imposing austerity measures.

The financial accelerator operated the other way around during the downturn phase. In accordance with the balance sheet effect, the average property price in Portugal dropped by 2.84% to €1128 per sq.m. As the environment became riskier, banks started charging higher interest rate, imposing a higher cost of debt repayment. For households, the credit market became inaccessible, while firms reduced their investment even more. Worries about the debt sustainability were spreading among the public opinion and the expectation of a dark future induced an increase in private savings. The aggregate demand declined sharply as a consequence of the reduced investments and the cut in expenditure.

While the upward change during the boom phase happened in a protracted period, the sudden stop required an abrupt adjustment. However, the Portuguese labour market was unable to adjust wages and prices in order to face the international competitiveness. During the slump most jobs were highly protected and covered by permanent contract. The rigidity of the market did not accommodate a smooth shift or resources to the non-tradable sectors, such that the productivity had been negatively affected.

The Portuguese housing market suffered a lot from the crises, and the average mortgage rate steady at 2.34% was a clear sign. Households stopped buying real estate since they had no access to the credit market. The demand for real properties dampen, while an increase in rental housing was recorded. For long time old buildings were abandoned and got deteriorated, such that the negative effect on the housing market was even amplified. One of the objective of the Troika memorandum for Portugal included the liberalization of the housing market, that also involved a  decrease in restrictions on foreign property ownership in Portugal.

Since 2014, GDP growth in Portugal became positive again, but its growth rate is still timid. Nonetheless, the gradual recovery of the economy is reflected on the constructions sector and the housing market. After more than three years of depression, house prices in Portugal started to recover in 2014 and the same trend is registered for the productivity in the construction sectors. The Bank of Portugal highlights the investment in houses has been growing way above the economic activity rhythm. Yet, most of the capital corresponds to equity capital and comes from other countries. The question to account for is whether the house prices are being over-evaluated or they are a consistent sign of the Portuguese recovery.

To conclude, it has been highlighted that the financial market liberalization impacted the development of the housing market in different ways. First of all, a reduced borrowing rates generated euphoric behaviors in the credit market. The consequences spread to consumptions  and investments through the financial accelerator. Second, a large capital inflow generate an inflationary trend in the non-tradable sector, thus a resallocation of employment. When the boom phase came to an end, the economy struggled to stabilize. The wage stickiness in the Portuguese labour market prevented the supply side to adjust, having a negative effect on productivity. Currently the Portuguese economy is recovering and real estate prices are growing promptly. Is this time different?


Ornella Dellaccio [31461]



Banco de Portugal (2014). The Dynamics and Contrast of House Prices in Portugal and Spain. Economic Bullettin. pp.39 – 52.

Blanchard, O. (2006). Adjustment within the euro. The difficult case of Portugal. Portuguese Economic Journal, 6(1), pp.1-21.

Blanchard, O. and Portugal, P. (2017). Boom, Slump, Sudden Stops, Recovery, and Policy Options: Portugal and the Euro. SSRN Electronic Journal.

Reis, R. (2013). The Portuguese Slump and Crash and the Euro Crisis. Brookings Papers on Economic Activity, 2013(1), pp.143-210.



The Irony of the Euro – From the promise of prosperity to the fate of thrift

When the euro was “physically” introduced on January 1st, 1999 a new world of endless possibilities seemed to be emerging for participant countries. With the introduction of a single currency across European Union countries, a brand-new single and more transparent market was expected leading to a strong economic and political integration with more competitiveness and subsequently overall growth across all member countries. However, “A single currency to work over a region with enormous economic and political diversity is not easy” (Stiglitz, 2016:8) and although for a while everything went according to the original plan, huge problems arose after the 2008 financial and economic crisis. This article aims at understanding what were the constraints imposed by the euro as a common currency when having to respond to the financial crisis in Portugal, namely the costs of losing one very important tool: either exchange rate or monetary policy.

In the run up to and following the introduction of the euro, Southern European countries could borrow at lower interest rates than before, since they were at that moment considered less risky and the European Central Bank ran several anti-inflationary policies. Hence, there was a large inflow of capital to these countries (Feldstein 2012). Despite this, data reveals lower productivity growth in the Southern European Union countries when compared to the rest. Studies suggest that this was due to the boom in construction and to the movement from tradable to non-tradable sector, characterized by slower productivity growth (Benigno and Fornaro, 2014; Reis, 2013). Authors such as Gopinath et al. (2015) have also suggested that lower productivity might be due to a misallocation of capital which led to lower total factor productivity. Since the introduction of the euro, Portuguese GDP has only grown three years above 2%. Through almost two decades, the growth rate of Portugal has mostly been around zero or one percent, and even negative in some years (-2.98% in 2009; – 4.03% in 2012). Only in 2014 did the economy began recovering, reaching a 2.8% growth in the first trimester of 2017 (1). As for the unemployment rate, it increased since 2008, reaching 16.2% in 2013, the third largest in the European Union, higher than what had been seen in many years, following Greece and Spain (2). Portugal’s interest rate reached 10,5% in 2012 the 2nd highest, after Greece (3).

Monetary policy is a helpful tool in solving external and internal issues that Portugal has given up when decided to join the common currency. On the one hand, it can be used as a current account stabilizer. As to fix external deficit, a country might use currency depreciation or devaluation. For that, banks must intervene by issuing currency or decreasing interest rates. The decrease in the interest rates will have two consequences: on the one hand, it will increase the demand for foreign currency, thus increasing its price and subsequently depreciating home currency which is the aimed effect; on the other hand, it will result in a capital outflow, the more one decreases the interest rate, which may have a big impact in the economy since foreign investment will fall substantially. That said, any institution with the authority to perform such operation should be very careful as not to force too much the depreciation but rather let it happen naturally.

In addition, monetary policy can be used for correcting inflation – the primary goal of the European Central Bank. If inflation is expected to rise, countries might increase interest rates as to drive demand for goods and services down (making access to credit harder) and hence soften the inflationary pressures. However, increasing interest rates drives demand for home currency up which will drive its price up and result in an appreciation. This appreciation though, if excessive, might harm the countries competitiveness and hence worsen its current account. Not to forget though, that this topic has been given a lot of attention from the ECB and hence it is not the major problem.


Furthermore, this tool can be used as an economic growth booster as well as a measure to fight unemployment. By decreasing interest rates, banks are facilitating access to credit and therefore promoting consumption and investment which accelerate the economy. Also, through open market operations, i.e. buying debt to commercial banks in return for money, monetary policy increases banks liquidity which might be responsible for an increase in loans to families and companies. If Portugal was not in the Eurozone, it could attempt at solving any of these mentioned problems by using money as a tool. With a common currency however, there is only one common monetary policy which means that, when faced with asymmetric shocks, there will be a common answer thus not all economies will have their needs satisfied.

Without the euro, Portugal could have an essential instrument to stimulate economic growth: the exchange rate. Portugal could compete in prices with Germany, for instance, through a devaluated currency. With the euro, it’s stuck competing with much stronger and much less devastated economies. In this sense, there was a failure in creating institutions that would overcome this. Also, despite being always negative, there is a significant fall in the current account from 1996 till 2009. By 2013, it reaches its highest level and afterward decreases a bit again (4). Consumption has decreased in these years meaning that the increase in the current account is not only due to an increase in exports but above all to a decrease in imports (5).

Some economists, such as Alesina, Barbiero, Favero, Giavazzi, and Paradisi (2015, January), a reference for Troika, believe that countries can still benefit from the same effects of a currency devaluation (increase in external competitiveness) through a decrease in nominal wages – austerity. In their opinion, by reducing salaries, companies can decrease their production costs and subsequently their prices, thus increasing competitiveness with foreign countries. I believe that the Southern European Union countries recent experience has shown several flaws of this assumption. First, because a fall in prices through this mechanism is a fall in all prices, not only on tradable goods’ prices (as it would happen with currency devaluation). As a matter of fact, housing prices fell drastically between 2009 and 2013 which corresponds to an asset devaluation, characteristic of a period of crisis (6). This means that the overall economy becomes worse, whether internally or externally and therefore, an income effect will occur, which will be responsible for a general reduction in consumption, as we saw between 2011 and 2014 (see (5)). On the other side, a currency devaluation incites investment in tradable goods sector, since imports become a higher burden. This can have a positive structural effect on the external position of the country, meaning that it will become more competitive before its foreign rivals.

Finally, unlike what was used as an argument in favor of the introduction of the euro, joining a big currency union while being less productive than most member countries did not lead to economic convergence but rather to increase external dependence, worsening the current account deficit. In the Eurozone, when a country imports more than it exports, which is the case of Portugal, a domestic shortage of money tends to occur, requiring borrowing from abroad and hence an aggravation of the external debt. Also, since borrowing has limits, lender countries will keep on lending up to the point where they do not longer consider the borrower country to be solvent and then a sudden stop becomes imminent. At that point, the borrower hits bankruptcy, as it happened with Greece and almost with Portugal, and ends up stuck with a big external debt and no means of liquidating it. If Portugal and Greece had opted out in first place, most likely they wouldn’t have benefited from these borrowing opportunities and hence they wouldn’t have increased their debt up to the levels that they did. Despite week, without the euro these countries wouldn’t most likely have the economic performances that they did. Nevertheless, they wouldn’t be forced to pay an enormous external debt along with absurd interest rates and restrictions to all its policies, including fiscal and monetary. Therefore, they had to surrender to Troika’s requirements as to be conceived a bailout.

Throughout this article, a few arguments were presented on how the euro constrained the Portuguese economy, especially during the period of the financial crisis. Nevertheless, it is relevant to mention that these are merely assumptions and it is impossible to know for sure how it would have been if the Escudo had remained as Portugal’s currency. In fact, not joining the euro always entailed the risk of having to face very high interest rates during the early 2000s, while all the other countries would be benefiting from low interest rates since Portugal was never considered very reliable. This would have represented difficulty in obtaining financing and no capital flying in. Joining the euro has increased price transparency, since it is now easier to compare prices among the European Union and has abolished currency uncertainty. Still, the main issue here seems to be the failure in creating institutions that would overcome these obstacles, namely protecting less strong countries at least during an adjustment period. Putting countries like Portugal, Spain or Italy at the same level as Germany, Austria or even France is at least irresponsible and is at the source of the problems that the Eurozone countries have faced. The European Union faces now the challenge of having to restructure its institutions, making them stronger, more egalitarian and solidary, as all common projects should be, to overcome these problems and in this way, assure a long lasting common currency.


Macroeconomic Analysis NovaSBE Frederica Mendonça, 3688


Stiglitz, Joseph E. (2016) The Euro: How a common currency threatens the future of Europe, W.W. Norton & Company

Ferreira do Amaral, João (2013, Abril) Porque devemos sair do Euro, Lua de papel

Ferreira do Amaral, J. Louçã, F. (2014, Agosto) A solução Novo Escudo, Lua de papel

Gopinath, G. Kalemli-Ozcan, S. Karabarbounis, L. Villegas-Sanchez, C (2015, 28 September) Low interest rates, capital flows, and declining productivity in South Europe (Acessed 30th November 2017)

Data: The World Bank & OECD

The 1994’ peso crisis in Mexico


The aim of this article is to briefly describe and comment the crisis that was faced in Mexico as a consequence of the devaluation of the Mexico currency in December 1994. It seems an interesting event to discuss, in light of what was studied in classes especially in the context of the chapter studied “Capital flows and the real exchange rate”, but also regarding other topics studied in class. It is essential to bear in mind that the analysis made in this article is not a detailed one. The purpose is only to try to explain the main factors and events and discuss an overall view of this crisis.

In the begging of the decade of 1990, Mexico seemed to be doing well. The economy was growing, in contrast to what happen throughout the previous decade. Inflation was being controlled, along with continuous confidence of foreign investors that were pumping money into Mexican economy, and also the central bank was accumulating a large quantity of dollars in their reserves. Along with these good performances (or also as a consequence of them) Mexican and US government agreed to reduce trade barriers between the two countries. The North American Free Trade Agreement (NAFTA) was then extended to the Mexican country, entering in vigor in the beginning of 1994.

But 1994 was a different year. Some events lead to some political instability, which made investors demand for an increasing risk premium on Mexican assets. Ultimately, this lead to a depreciation in peso of about 15 percent (against the dollar) in December 1994. But within days, the new peg of the exchange rate was abandoned and Mexico was doomed to seek for international help from the US, IMF and G7, among others. The consequences were rough on Mexico, with the financial sector bearing several damages. Several banks went bankrupt, revealing low quality assets and fraudulent practices. The country faced a hyperinflation situation with prices going up in about 35%. With these levels of inflation, and with nominal wages remaining constant, real wages faced a several decline. Unemployment almost doubled, and GDP declined about 6,2% throughout 1995.


At that time (beginning of the 1990’s), Mexican central bank policy aimed to maintain a fixed exchange rate between pesos and US dollars. They would do so by intervening in the exchange market, buying or selling pesos to maintain the rate within a narrow band.  The strategy was to issue short-term public debt expressed in US dollars. With this borrowed dollars they would buy or sell pesos. The upper limit of the band was increased by a very slight preannounced amount every day, letting pesos depreciate in nominal terms. However, this depreciation in nominal terms was not being reflected in the real terms. The real exchange rate is given by: R = (eP*)/P, where R is the real exchange rate, e stands for the nominal one (e represents the price of foreign currency in units of the domestic one), P* are the foreign prices (in this particular case US Dollars) and P the price level of the home country (Mexico Pesos, in this example). A higher R means that foreign goods are becoming relatively more expensive. In that way, we say that the real exchange rate is depreciating. What was happening in the early 90’s in Mexico was the opposite: Inflation there was consistently higher than the sum of the nominal exchange rate and inflation in the US. Therefore, R was decreasing constantly besides the fact that nominal exchange rate was always maintained constant (within the above mentioned band). Foreign goods were becoming relatively less expensive what lead to an increase in demand for imported goods, and decrease in exports. This lead to a major deficit in the Mexican trade balance. Investors started to believe that pesos were artificially overvalued what translated into a speculative flight of capital. Despite this, Mexico government seemed not to be worried about this deficit since their reserves of US dollars were growing through the end of 1993.

Throughout 1994 several events happened that also triggered this capital flight. Among them are the rebellion in the southern province of Chiapas in the beginning of the year and the assassination of the presidential candidate Luis Donaldo Colosio in March, events that made investors skeptical about the political and financial stability of the country, pressing interest rates to go up (higher risk premiums required) and reinforced the downward market pressure on peso. The efforts that the central bank made to counteract the depreciation of the peso eventually, at the end of 1994, end up emptying out all the US dollars reserves of the central bank.


The collapse of the economy came on December 20 with the announcement of the central bank that they would allow peso depreciate about 13% to 15%. This announcement went against all the expectations that investors had about the central bank currency policy, since they did not had left peso depreciate for quite some years. As we studied in the course, in the context of Rational Expectations the mistrust in central bank policy makers made investors fear additional devaluations and made capital flight even bigger and placed even higher risk premium on domestic assets, pressing interest rates to go up. As a response to this capital flight, particularly from debt instruments, the central bank decided to raise interest rates. But as we know, interest rates are negatively correlated with consumption and investment. In that sense, higher interest rate deviates consumption and investment to savings, preventing economic growth to take place. And that was essentially what happened.

When the time for repaying his maturing debt obligations came, few investors were interested in purchasing new debt. To repay the debt that was issued in US dollars (tesobonos), the central bank had to buy dollars in the exchange market with the weakened pesos and this proved to be very expensive. At this point, Mexico government faced imminent sovereign default.

Two days later, on December 24, the central bank allowed the currency to float. Another 15% depreciation took place. The consequences were devastating and at the end of 1995 Mexicos’s hyperinflation had reached more than 50%.


While Mexican’ currency devaluation came as a surprise to many, since it was against all the past decisions of the central bank, a review of the record seems to show that a crisis maybe was inevitable. As plenty of economists have tried to warn at the time, peso was somewhat overvalued. The question was if a devaluation of the peso could take place without initiate a major financial crisis. Despite the fact that the decision of devalue the peso had been really harsh criticized, markets seem to have response quite well, given the circumstances, during that day (December 20). The only sign of trouble was that the amount of weekly sell of tesobonos was less than the amount offered. Besides that, yield and total bids received were quite satisfactory. The next day, the loss in government credibility was noticed, and a $4.5 billion loss in central bank reserves happened because investors shift funds out Mexico. It is my belief that, considering the reserve losses throughout the year of 1994 and the large amount of short-term funds that could potentially leave the country, the government could and should have take measures to avoid this outflow. For example, arranging a short-term loan agreement with the US or IMF prior to the devaluation announcement, instead of afterwards. The next day, government announced that it would let exchange rate flow and a credit line arranged with the US and Canada. A financial crisis of a big scale had started. The reserves were now reduced to less than $6 billion, interest rate went up, peso devaluated a lot, and government access to credit was brutally reduced. The harsh response of the markets at the decision of dropping the fixed exchange rate on December 24, against the not so harsh response of the markets to the devaluation imposed in December 22, suggest that Mexico would probably be better off by increasing the target band’s rate of crawl and making an earlier decision of devaluate while reserves were still quite high, than to decide to let the rate floating. Several policy decisions from Mexico Government and Central Bank were criticized and in 1995 the country had to appeal for a bail-out organized by the US and the IMF.

The interesting part of analyzing this financial crisis is that, in same sense, covers a lot of issues discussed in the Macroeconomics Analysis course. Among them, exchange rate and its implication on the trade balance of one country, interest rates and how economy growth responses to it, animal spirits, rational expectations and flying capital, government debt and sudden stops.


Afonso Pereira da Silva Souto de Moura

Student number 3717

Is the slow growth of global economy here to stay?

It all began at the end of the Great Depression in 1938, when Alvin Hansen, a disciple of John Keynes, suggested a new hypothesis – the “secular stagnation” hypothesis – for the economic situation that was happening at the time. He argued that the U.S. economy would never grow in the same way and that the Great Depression could be the beginning of a new era in which there was no force capable of bringing the economy to full employment, due to persistent unemployment rates and economic stagnation (there was a deterioration of the birth rate and an excessive supply of savings that was repressing the aggregate demand). He claimed that the only remedy was a high and constant government deficit spending. However, this theory was contradicted and lost its strength a few years later: the demand expanded with the increase in government spending caused by the World War II and the problem of excess savings was mitigated by the post–World War II baby boom.

More recently, this theory has recovered its power. On the one hand, we can analyze the case of Japan in the 1990s and the Euro Area’s situation in the last decade: a lower GDP growth, a decline in population growth and a nominal interest rate close to zero. On the other hand, we have the financial crisis of 2008, which is considered by many economists as the worst global financial crisis since the Great Depression. And here, just as Alvin Hansen was referred in the beginning, I must also name Lawrence Summers, who brought this concept back again – he believes this theory is still applied today and that this secular (long-term) stagnation is the main economic problem of our time, particularly if the central banks do not worry about keeping inflation low and the fiscal authorities do not worry about high debt. He says that it may be the reason why U.S. economic growth is not sufficient to reach full employment. With a negative short-term real interest rate, any attempt to expand demand (coming from financial strategies) wouldn’t produce any excess demand – creating a huge difficulty to get the economy back to full employment.


Japan and the Eurozone: Forecast versus Reality

Let’s take this possibility seriously

After Mr. Summers’ speech at the IMF’s Annual Research Conference in 2013, Paul Krugman pointed out some real facts that make the circumstance for secular stagnation disturbingly credible. He started by saying that liquidity trap situations are becoming increasingly common – making monetary policy less effective – and that there is a huge probability of reaching the zero-lower bound. He also denoted a secular descending movement in long-term real interest rates even before the financial crisis of 2008 and an increasingly weak demand – due to the end of ever-increasing leverage and demographic deceleration.

It is reasonable to say that these factors alone can not justify the pure existence of secular stagnation. But, of course, they can create substantial problems in policy terms. In a monetary policy approach, the most credible strategy that can be done under zero-lower bound is to convince the population that the central bank will have an expansionary behavior to create some inflation and high demand (even after the improvement of the economy). However, the central bank must ensure that this inflation target is high enough to produce an economic expansion (and as long as people continue to believe in the monetary authority’s promises). Basically, as Paul Krugman said, “the central bank needs to credibly promise to be irresponsible”. Furthermore, Krugman (2014) shaped these results and created a new concept: the “timidity trap”. This means that, when an inflation target is not high enough, it will have no effect in an economy facing a secular stagnation.


The “timidity trap”

This graph shows an aggregate demand curve that is depending positively on (expected) inflation and a hypothetical non-accelerationist Phillips curve (that demonstrates the dependence of the rate of inflation on output). Additionally, a 2% inflation target is being hypothetically announced by the central bank.

Moving towards fiscal policy matters, Krugman defends that this output gap can be alleviated by an income redistribution from saving people to borrowing people (nevertheless, it should be taken into account the specificities of such procedure). Alternatively, if the problem is temporary, another possibility is an increase in government spending which acts as a demand support until the private sector reaches the normal spending standards. Once that has materialized, monetary policy can continue the process of maintaining demand in regular levels while the government solves its deficit problem. However, these temporary fiscal incentives to support demand may not be sufficient if non-positive natural rates are lasting.

Are they just doomsayers?

Joel Mokyr believes that the observed slow growth in the late 1930s was due to the lack of investment opportunities. In his view, the ongoing technological evolution – that led to higher productivity levels and a huge rise in economic welfare from the mid-19th century – contradicts this so-called secular stagnation. Even though technological improvements may split labor markets, they also generate benefits that are not accurately displayed in current data. In this sense, he claims that measured economic growth underestimates the effect of technology on society’s welfare because there are many products imperfectly quantified.

A new challenge

Many recent studies highlight the negative influence of an ageing society on the growth of its economy. Two possible reasons for this existing negative relationship are that ageing people could generate excessive savings over desired levels of investment; and that there is a lower labor force participation (in addition to lower productivity of older employees).

However, a new research published by the National Bureau of Economic Research and performed by Acemoglu and Restrepo challenges the view of secular stagnation and raises some doubts about this theory: they found that there is no negative relation between slower growth of GDP per capita and population ageing. Therefore, their finding is not in accordance with the widely discussed secular stagnation theory labelled by Lawrence Summers.

So… Gloom or boom?

The different perspectives discussed above allow for a better understanding of the complexity of the challenges faced by the global economy.

On the one hand, we have the pessimists who argue that the economy is buried in a non-existent growth due to the actual depressed aggregate demand and that “sad days are here again” – so policymakers need to adjust their actions to a world that is in trouble. On the other hand, we have those who argue that technological progress proves that pessimists are wrong and defend that the world economy is not suffering from a global imbalance resulting from a fall in the propensity to invest and a growing propensity to save.

I think we must remember that if there is, in fact, a secular stagnation problem, the likelihood of contagion is increased by economic weakness. For now, the central point is that the actual possibility that our economies entered in an age of secular stagnation involves a necessary rethinking of macroeconomic policies.

Margarida Araújo




[1] Teulings, C. and Baldwin, R. (2014). “Secular Stagnation: Facts, Causes and Cures“. CEPR Press.

[2] Summers, L. (2014). “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound”. Business Economics.

[3] Krugman, P. (2013). “Bubbles, regulation, and secular stagnation”. The New York Times.

[4] Hansen, A. (1939). “Economic Progress and Declining Population Growth”. American Economic Review.

[5] Acemoglu, D. and Restrepo, P. (2017). “Secular Stagnation? The Effect of Aging on Economic Growth in the Age of Automation”. National Bureau of Economic Research.