Few people can have been very surprised when the IMF announced this week that it was lowering its growth projections for this year. It feels like that’s been the story of the recovery in much of the OECD – a succession of disappointments and dashed hopes. Today, seven years after the financial crisis, growth remains well below where it was pre-crisis and unemployment well above.
All this begs a question: Is there something wrong with the economy? Some leading economists fear there is, and they’ve given it a name – “secular stagnation.” The expression was coined in the 1930s and famously revived in 2013 by Larry Summers, a former US Treasury Secretary. It may sound strange, but all it really means is “persistent stagnation.” Whatever you call it, it’s causing a lot of concern, including, no doubt, among the global movers and shakers at Davos this week.
What is persistent stagnation? As The Economist notes, it’s a “baggy concept” that’s hard to pin down. Still, there are a few ideas that crop up repeatedly. Most notable is the idea that it describes a period when interest rates can’t be pushed low enough to provide the economy with the stimulus that it needs.
To explain: In normal economic times, interest rates are among central banks’ most powerful weapons. When the economy’s overheating, central banks can raise rates, making it more expensive to borrow, which puts a brake on consumers and businesses; when the economy’s cooling, they can send rates back down to encourage consumers and businesses to borrow and invest more.
That weapon’s currently proving much less effective. Inflation is very low, as are real interest rates – in other words, the return on money once inflation is accounted for. Today, many economists believe the economy would need a real rate of interest well below zero in order to shift money out of what Martin Wolf calls the “global savings glut” and into productive investment. But because inflation is so low, that would require nominal (or advertised) interest rates to also go well below zero. And that, by general agreement, can’t happen.
Yes, it’s true that some national central banks, such as in Sweden and Denmark and, more recently, Switzerland, have experimented with negative nominal interest rates, as did the European Central Bank (ECB) in 2014. But the rates weren’t much below zero and usually didn’t apply to all the rates set by the bank. This “zero lower bound” limit on interest rates explains why central banks have sought other ways to boost the economy in recent years, most notably quantitative easing – a step the ECB is widely expected to follow this week.
So what’s causing this situation? There’s no shortage of theories, but broadly speaking a range of factors – often interrelated and self-sustaining – may be dragging down the economy, both in the short and longer term. Take unemployment: Despite some recent signs of improvement in the jobs market, joblessness remains worryingly high in many OECD countries. As time goes on, at least some of those without work risk seeing their skills become outdated, may lose the will to go on searching for work or may become unfairly stigmatised as “unemployable”. That robs the economy both of workers and of workers’ spending power.
Business investment is also an issue (albeit a complex one). In theory, the current low interest rates should make this an ideal time for businesses to borrow. In practice, this doesn’t seem to be happening, probably because of economic uncertainty and because many firms are already sitting on large stockpiles of cash.
There are longer-term drags on the economy, too, such as the slowdown in population growth and the ageing of our societies, which will leave a rising number of retirees dependent on a declining number of workers. And there’s widening inequality – as highlighted at Davos by Oxfam – which may play a role by reducing overall consumption, as Robert Peston notes: “The poor in aggregate spend more than the rich (there are only so many motor cars and yachts a billionaire can own, so much of the super-rich’s wealth sits idle, as it were).”
So, if interest rates won’t work to boost the economy, what will? An OECD paper released this week at Davos argues for a comprehensive stimulus package, especially in the euro area and Japan, where signs of stagnation are arguably strongest. It calls for action in four main areas: Encouraging investment by, for example, establishing public-private partnerships and reducing the incentives for firms to buy back shares; supporting SMEs and entrepreneurs; promoting trade by, for example, making customs procedures more efficient and liberalising the services sector; and raising employment by supporting job-seekers and encouraging women and older workers into the workforce.
“Secular Stagnation: Evidence and Implications for Economic Policy,” by Łukasz Rawdanowicz, Romain Bouis, Kei-Ichiro Inaba and Ane Kathrine Christensen (OECD, 2014)
What Do Company Data Tell Us?” by Adrian Blundell-Wignall and Caroline Roulet (OECD, 2014)
OECD Insights: From Crisis to Recovery (OECD, 2010)