Global Economy
World Economy: Secular stagnation or a new normal
By Michael Hennigan, Finfacts founder and editor
Nov 24, 2014 - 6:09 AM

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The world economy risks getting stuck with a mediocre level of growth—low growth for a long time, Christine Lagarde, IMF managing director, said in early October. “If people expect growth potential to be lower tomorrow, they will cut back on investment and consumption today. This dynamic could seriously impede the recovery, especially in advanced economies that are also grappling with high unemployment and low inflation.” Not much has changed in the interval and whether it's called secular stagnation or a new normal, in less than a decade, the over-65s will outnumber the under-5s—for the first time ever, which is just one of the challenges ahead.

Annual Eurozone inflation was 0.4% in October; Brent crude oil prices have plunged about 30% since mid-June on concerns that a global glut of oil would persist into next year and at the end of October, it was reported that adjusted for an increase in the sales tax to 8% from 5% in April, Japan's core consumer-price index rose 1.0% from a year earlier in September. The figure was the lowest in 11 months, moving further away from the central bank’s price target of 2% to end 15 years of deflation.

On Friday, Shinzo Abe, Japan's prime minister, dissolved parliament's lower house and a snap election is scheduled for December 14, with the government seeking a fresh mandate for struggling "Abenomics" of massive monetary easing and structural reform, just two years after Abe returned to power promising that "Japan is Back" - on last Monday it was reported that the Japanese economy was back in recession as consumers cut spending in response to the April sales tax hike.

Also on Friday, Mario Draghi, ECB president, stressed that the central bank was ready to take serious action to raise inflation expectations while the People's Bank of China (PBoC) cut interest rates.

"We will do what we must to raise inflation and inflation expectations as fast as possible," Draghi told bankers at a conference in Frankfurt.

"If ... our policy is not effective enough to achieve this, or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases," he said.

The ECB said on Friday it had begun buying asset-backed securities and further measures could include large-scale purchases of government bonds—similar to the quantitative easing (QE) programs that the United States, Japan and the UK have undertaken.

There are however doubts in Germany about QE while Jean-Claude Juncker, European Commission president, is due to announce an EU infrastructure stimulus program this week.

"It has never been cheaper for countries such as France to borrow," said Michael Heise, the chief economist of Allianz, as reported by Reuters. "Buying state bonds could influence the price of state bonds, but wouldn't have much impact on the economy."

China cut its benchmark lending rate by 0.4 percentage points on Friday, while only lowering its deposit rate by 0.25 percentage points.

In addition, the PBoC allowed banks to set their own deposit rates up to 20% above the benchmark, compared with a previous ceiling of 10%.

Secular stagnation/ new normal

In 1937-38, the US recovery from the Great Depression, which was far from complete, went into reverse: real GDP fell 11% and industrial production tumbled 32%, making it the third-worst US recession in the 20th century (after 1929-32 and 1920-21).

In December 1938, Alvin Hansen (1887-1975), Harvard University economist and president of the American Economic Association, in his address to the annual meetings of the association, titled "Economic Progress and Declining Population Growth," (published March 1939) argued: "We are...rapidly entering a world in which we must fall back upon a more rapid advance of technology than in the past if we are to find private investment opportunities adequate to maintain full employment. ... It is my growing conviction that the combined effect of the decline in population growth, together with the failure of any really important innovations of a magnitude sufficient to absorb large capital outlays, weighs very heavily as an explanation for the failure of the recent recovery to reach full employment."

Hansen added: "This is the essence of secular stagnation—sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment."

Nazi Germany and Imperial Japan put an end to fears of secular stagnation and last year Larry Summers, a contemporary Harvard economist and former Treasury secretary, spoke on secular stagnation in February 2014 and argued three propositions [pdf]. "First, as the United States and other industrial economies are currently configured, simultaneous achievement of adequate growth, capacity utilization, and financial stability appears increasingly difficult. Second, this is likely to be related to a substantial decline in the equilibrium or natural real rate of interest. Third, addressing these challenges requires different policy approaches than are represented by the current conventional wisdom."

Prof Summers in 2013 also made interesting contributions here (IMF conference) and here [pdf] where he said at a lecture on automation: "Until a few years ago, I didn’t think this was a very complicated subject; the Luddites were wrong and the believers in technology and technological progress were right. I’m not so completely certain now."

Goldman Sachs, the investment bank says its Current Activity Indicator (CAI), a composite figure of 25 US economic indicators has increased by 3%, the fastest since the recession and its expects above trend growth until 2017.

In the Financial Times last September Summers wrote:

Given the factors operating to reduce natural interest rates – rising inequality, lower capital costs, slowing population growth, foreign reserve accumulation, and greater costs of financial intermediation – it seems unlikely that the American economy is capable of demanding 10 per cent more output than it does now, at interest rates consistent with financial stability. So demand-side secular stagnation remains an important economic problem...But, as the work of Robert J Gordon has shown, there may now be supply-side barriers that threaten to hold back the economy before constraints on the ability to create demand start to bind. Two ways of looking at the current situation point up the difficulty."

and he added: "Why has the economy’s supply potential declined so much relative to the pre-2007 trend? This will be debated in the years to come. Part of the answer lies in the damaging effect of past economic weakness on future potential. Part is the brutal demographics of an ageing population, the end of the trend towards increased women’s labour force participation, and the exhaustion of the gains from an increasingly educated workforce. And part is the apparent slowing of at least measured productivity."

Real US GDP rose an average of 3.4% per year from 1960 through 2007 and in 2010 I wrote on Finfacts about the so-called 'new normal," which is an expectation that such a sustained growth rate cannot be expected to be replicated in the US anytime soon.

In the advanced world, the recent economic performance of the Eurozone and Japan suggest that is not a crazy expectation..

This month Federal Reserve economists published the results of research covering quarterly real GDP data for 23 advanced economies from around 1970 to present, identifying 149 recessions (117 recessions if the Great Recession is excluded) and they say that the historical experience of advanced economies around recessions indicates that the current experience of a slow recovery "is less unusual than one might think. First, output typically does not return to pre-crisis trend following recessions, especially deep ones. Second, in response, forecasters repeatedly revise down measures of trend."

In another report, 'In the Shadow of the Great Recession: Experiences and Perspectives of Young Workers' [pdf], Fed economists say that "young adults in the United States have experienced higher rates of unemployment and lower rates of labour force participation than the general population for at least two decades. The Great Recession exacerbated this phenomenon...Despite the importance of education and work experience, intangibles still play a role in the labor market. According to the survey results, finding a job is still heavily based on personal connections. Respondents identified personal networks as a primary source in their job search process."

The trend of higher unemployment among the young has also been evident in Europe for decades.

Pavlina R. Tcherneva, an economist at Bard College, New York, in a 2013 paper [pdf] argues that conventional US monetary and fiscal policies reinforce inequality and the chart above starkly illustrates how the distribution of the economic gains have been shared from the 90% capturing all the income gains in 1950-53 while from 2001 to 2007, 98% of income gains accrued to the top 10% of earners.

Finfacts reported last February that the richest 5% of Americans account for 40% of consumer spending.

Last week on the Economist's Free Exchange blog the Data Team pointed to ageing as a factor in depressing growth.

They says that in both Germany and Japan, "the working-age population (those aged 15-64) has been shrinking for more than a decade, and the rate of decline will accelerate in coming decades. In Britain, the population will stop growing in coming decades while in America, it will grow at barely a third of the 1% rate that prevailed from 2000 to 2013. Population patterns affect investment and savings. Firms need a given capital stock per worker—equipment, structures, land and intellectual property—in order to produce a unit of output. If output growth is hampered by lack of workers, firms will need less capital. Ageing populations also mean that more people are saving heavily in order to fund their retirement, depressing consumption."

Coupled with a squeeze on consumption is the weak growth in pay:

Between 1991 and 2012 the average annual increase in real wages in Britain was 1.5% and in America 1%, according to the Organisation for Economic Co-operation and Development, a club of mostly rich countries. That was less than the rate of economic growth over the period and far less than in earlier decades. Other countries fared even worse. Real wage growth in Germany from 1992 to 2012 was just 0.6%; Italy and Japan saw hardly any increase at all. And, critically, those averages conceal plenty of variation. Real pay for most workers remained flat or even fell, whereas for the highest earners it soared. Technological changes may deepen such polarisation. In a 2013 paper Carl Benedikt Frey and Michael Osborne, of Oxford University, analysed over 700 different occupations to see how easily they could be computerised, and concluded that 47% of employment in America is at high risk of being automated over the coming years."

See here and here for the Economist's posts.


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