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)