Tuesday 31/03/2020

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The curse of secular stagnation

Chief Economist

The disappointing recovery following the 2008 Great Financial Crisis has brought to life Alvin Hansen’s thesis of the late 1930s. Regular readers of this blog are aware that we have been referring to the risk of a long period of very low interest rates and subdued growth before. Hansen was wrong. But he was wrong in way he still might be right after all.

With Western economies suffering from the Great Depression overhang, the American economist Alvin Hansen argued that the economy was dealing with a chronic economic imbalance stemming from a lack of capital absorbing investment and high propensity to save. Weak demographic prospects and insufficient investment opportunities threatened to push the economy in a more permanent state of relatively slow growth in combination with very low interest rates. World War II of course completely overturned this scenario. The US government’s ‘war machine’ absorbed the excess of private savings and the unemployment rate dropped from 11% in 1940 to 1% in 1942. What’s more, the post-war period was characterized by public investment in suburbs, higher fertility rates, adoption of war-time technology and pent-up consumer demand. Hence, Hansen’s secular stagnation table was off the table.

Or so it seemed. American economist Larry Summers, former chief economist of the World Bank, resurrected the idea in 2013. And unfortunately, experience since then more or less confirms his thinking. Eight years after the start of the Great Recession, the global economic recovery is still hesitating, demographic headwinds are intensifying and nominal interest rates are at all-time lows. Real policy rates are in negative territory and were already structurally trending down since the 1980s, even despite relatively favourable demographics and debt-fuelled private spending booms.

But while the scenario of secular stagnation is clearly possible, it is not inevitable. Secular stagnation has lots of similarities with the liquidity trap. Here also, excess savings over investment drive down real interest rates. The difference is that, in contrast to secular stagnation, the liquidity trap situation tends to point to a more temporary state of affairs. It’s impossible to know what lies ahead of us. Anyway, more expansive fiscal policy is what the doctor would order in both situations. What then about all the talk of digitization, artificial intelligence, robotics and the like? It has become simply impossible to ignore that a lot is going on in terms of innovation. Things are moving fast indeed. But how this translates into productivity or employment is another important question. We will try to tackle this question in one of our next blogposts.