Over recent weeks the debate over secular stagnation has been reignited (or perhaps the better analogy is that more fuel has been poured on the fire) in both the US and the UK. In the US, the Foreign Affairs journal has devoted a special issue to Surviving Slow Growth, with articles by former US Treasury Secretary Lawrence Summers, among others. In the UK, in the Budget, the Office for Budget Responsibility revised down its projections of potential output growth to around 2 per cent per annum between now and 2020. So should we be concerned about the new normal, or is the reality something far more benign?
Clearly we have experienced an extraordinary period over the last six years. As Summers points out, no one in 2009 imagined that US interest rates would stay near zero for this long, that key interest rates in Europe would turn negative and that central banks in the G7 would balloon their balance sheets by more than $5 trillion. But the benign interpretation of current events is that employment in the US and the UK has risen to record levels and the unemployment rate has fallen to around 5 per cent in both countries.
The more malign interpretation is that we still have a growth problem, though there is less agreement among economists as to what is causing it. Summers attributes the problem to Alvin Hansen’s 1930s concept of secular stagnation. Kenneth Rogoff points to the theory of a debt overhang. Richard Koo highlights the concept of a balance sheet recession. Ben Bernanke focuses on the theory of a savings glut, and Paul Krugman reminds us of the Keynesian concept of a liquidity trap. Finally, in a switch of tack, Robert Gordon cites the problem of supply-side headwinds.
The implication of Summers and others is that economic policy needs to switch towards expansionary fiscal policy. According to this view, the rise in the public debt to GDP ratio since 2008, from 73 per cent to 106 per cent in the US, 69 per cent to 93 per cent in the Eurozone and 52 per cent to 88 per cent in the UK, needs to go further. Summers, of course, would argue that had an even more expansionary fiscal policy been operated over the past six years, the US economy would now be at least a trillion dollars larger, and so the denominator in the public debt to GDP ratio calculation would be bigger as well.
It’s no surprise that the secular stagnation thesis, and other low growth theories, are back grabbing headlines. The financial market turmoil in early 2016 reminded everyone that, should the world economy slip into recession (or a period of even slower growth), the policy dilemma would be acute – even more extraordinary monetary policy or an expansion in public debt from already high levels. Neither option looks appealing.
So don’t expect the low growth debate to go away. Yet again there is a battle underway within the economics profession regarding the relative merits of monetary versus fiscal policy. Summers and other fiscalists are lined up on one side. But opposing them are those who argue that monetary policy can yet work via more QE or achieving escape velocity.
Escape velocity is attained when the banking system can expand the money supply to sufficiently maintain trend GDP growth, without the need for central bank intervention in the form of quantitative easing.
The battle lines are drawn.