'Secular stagnation' is an ugly term - let's hope we can avoid it

And we'd better make a wish, too, that the optimists are right on the reasons why growth is struggling

Hamish McRae
Saturday 18 April 2015 18:30
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It is an ugly expression to describe an ugly prospect: “secular stagnation”, which means at best a long period of below-trend economic growth and at worst no growth at all.

The idea behind this is that something seems to have gone wrong with the growth machine that has driven the developed world since the Second World War. Instead of each generation becoming on average richer than the previous one, underlying growth has slowed so much that this will no longer be the case. To keep economies growing we will have to put in longer hours and increase the proportion of people in work. We will have to run harder to stay in pretty much the same place.

This concern has been around since it became clear that this world recovery was going to be much more of a slog than previous ones. In the past few months this has sharpened into a debate in the US between the optimists, led by Ben Bernanke, former head of the Federal Reserve, and the pessimists, led by Larry Summers, former Treasury Secretary. Bernanke thinks the problem is a mix of cyclical and special factors; Summers thinks there is a chronic global shortfall of demand. Both are top-flight academic economists and the discussion is spattered with references to “equilibrium real rates of interest” and suchlike. But there is a looming policy issue that has direct implications for our next government: how quickly will interest rates rise?

The position is this. The monetary accelerator pedal is flat on the floorboards and has been for five years: near zero nominal interest rates and negative real rates just about everywhere. And while the fiscal pedal has been eased back a bit, all major economies bar Germany are still running unsustainably large deficits. Yet the results have been most disappointing. We have at last cranked things up in the UK, with unemployment now down to 5.6 per cent, and the US is growing, too, with unemployment down to 5.5 per cent. But most European countries are growing at less than 2 per cent a year, Italy and France much less, while Japan looks like having only 1 per cent growth. The central banks have printed industrial quantities of money, yet it seems to have gone largely into higher share and property prices rather than generating sustainable additional demand.

This leads to the policy dilemma. To oversimplify, if Bernanke is right, the US economy will be able to withstand a gradual rise in interest rates, whereas if Summers is right a rise in rates might choke off such growth as there is. The current Fed chair, Janet Yellen, acknowledged the dangers of secular stagnation in a speech last month but did not regard this as the most probable outlook. This has direct implications for us, for an early rise in US rates, starting in June, would give the Bank of England cover to begin increasing rates here.

There are longer-term implications too. Both major parties plan to clear the deficit and while their timetables to do so appear slightly different, in practice they would probably end up doing much the same. But they can only clear the deficit without increasing taxation sharply, which they have said they won’t do, if there is decent growth. Both are betting against the secular stagnation story turning out to be true.

So will it? Gosh, it is hard enough to know what will happen to the economy in the next few months, let alone the next 20 years. There is also a human instinct to project forward the present situation and assume it will broadly continue. Thus in the 1970s economists saw high inflation and labour strife continuing for a generation, with commentators predicting that Britain faced absolute decline. In the recessions of the early 1980s and 1990s there were similar bouts of decline-ism. Then in the late 1980s and the first half of the 2000s came bursts of over-optimism about the UK’s economic prospects that now seem quite hubristic.

So set the current mood aside and let’s focus on the UK and US. I think part of the problem, and this applies in slightly different ways to both countries, is that it has proved hard to increase productivity in many services that people want and need to spend their money on: notably education and health care. It has been easier to do so in manufacturing, but that is too small a part of the economy to help much.

Ageing populations, too, contribute to the problem.

Finally, there is no doubt that the financial crisis did longer-term damage; we had to learn to grow with weakened banks. There is evidence that recessions associated with financial crisis take longer to correct. We cannot yet know, but I incline towards Bernanke. In any case, we will get much more of a feel for how serious these are in the next three years. If both the US and UK can carry on growing swiftly – and that will mean big increases in productivity here – then that will say that human ingenuity counters secular stagnation. If not, the outlook is glum.

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