What ex­plains the great global slow­down

The Pak Banker - - OPINION - Vivek De­he­jia

WHO would have thought that a some­what ar­cane eco­nom­ics con­cept from the 1930s would oc­cupy cen­tre stage in eco­nomic pol­icy de­bates to­day? Yet, along with "fi­nan­cial in­sta­bil­ity", "sec­u­lar stag­na­tion" is now well on its way to be­com­ing a house­hold term. It be­fits an era of eco­nomic volatil­ity in a global econ­omy which is yet to re­cover fully from the great fi­nan­cial cri­sis of 2007-10.

Coined orig­i­nally by Har­vard econ­o­mist Alvin Hansen in the wake of the Great De­pres­sion, the term in re­cent years has been given new cur­rency by an­other fa­mous Har­vard econ­o­mist, Lawrence Sum­mers. Most re­cently, writ­ing in the in­flu­en­tial jour­nal, For­eign Affairs, Sum­mers ar­gued that sec­u­lar stag­na­tion holds the key to un­der­stand­ing the cur­rent global macroe­co­nomic sit­u­a­tion

But most sim­ply, sec­u­lar stag­na­tion refers to a sit­u­a­tion of in­suf­fi­cient ag­gre­gate de­mand, or, equiv­a­lently, a sit­u­a­tion of ex­cess ag­gre­gate sup­ply. While th­ese two def­i­ni­tions are equiv­a­lent, the first points to the de­mand side, and the lat­ter to the sup­ply side, as the source of the prob­lem.

Yet an­other equiv­a­lent, de­mand-side, def­i­ni­tion is to say that sec­u­lar stag­na­tion re­flects an ex­cess of sav­ings over in­vest­ment. This is, as a mat­ter of ac­count­ing, the flip side of in­suf­fi­cient de­mand for goods and ser­vices: as ev­ery stu­dent who has been taught the cir­cu­lar flow of goods and ser­vices in a first-year prin- ciples of eco­nom­ics class will know.

A some­what more tech­ni­cal def­i­ni­tion of sec­u­lar stag­na­tion is that it is a sit­u­a­tion in which the "nat­u­ral" or "neu­tral" real rate of in­ter­est is so low that it is im­pos­si­ble to achieve at a pos­i­tive, zero or even slightly neg­a­tive nom­i­nal in­ter­est rate. Re­call that the nat­u­ral or neu­tral real in­ter­est rate, a con­cept orig­i­nated by Swedish econ­o­mist Knut Wick­sell, is that real in­ter­est rate which bal­ances ag­gre­gate de­mand and ag­gre­gate sup­ply at full em­ploy­ment. While small neg­a­tive nom­i­nal in­ter­est rates are the­o­ret­i­cally and prac­ti­cally pos­si­ble, con­trary to what is some­times be­lieved, the nom­i­nal in­ter­est rate re­quired to equi­li­brate ag­gre­gate de­mand and ag­gre­gate sup­ply in a sit­u­a­tion of sec­u­lar stag­na­tion is so large and neg­a­tive that it would be im­pos­si­ble to achieve us­ing con­ven­tional mon­e­tary pol­icy.

The key rea­son is that de­pos­i­tors may tol­er­ate a small neg­a­tive in­ter­est rate as a con­ve­nience charge, but, fac­ing a large enough neg­a­tive in­ter­est rate, it would be cheaper to hold money in cash, even if one has to pay for stor­age and se­cu­rity. In the­ory, the govern­ment could di­rectly tax cur­rency hold­ing at what­ever rate it wishes, which would push even lower a sus­tain­able neg­a­tive nom­i­nal in­ter­est rate, but this seems im­prac­ti­cal and po­lit­i­cally dif­fi­cult.

Sum­mers ar­gues that the cur­rent global macroe­co­nomic pic­ture is en­tirely con­sis­tent with a sit­u­a­tion of sec­u­lar stag­na­tion. He writes: "Real in­ter­est rates are very low, de­mand has been slug­gish, and in­fla­tion is low, just as one would ex­pect in the pres­ence of ex­cess sav­ing. Ab­sent many good new in­vest­ment op­por­tu­ni­ties, sav­ings have tended to flow into ex­ist­ing as­sets, caus­ing as­set price in­fla­tion." As ev­i­dence in favour of the hy­poth­e­sis, Sum­mers points to de­clin­ing es­ti­mated neu­tral real in­ter­est rates and a body of re­search which doc­u­ments a range of fac­tors be­hind ris­ing sav­ings rates and de­clin­ing in­vest­ment rates.

To quote Sum­mers again: "Greater sav­ing has been driven by in­creases in in­equal­ity and in the share of in­come go­ing to the wealthy, in­creases in un­cer­tainty about the length of re­tire­ment and the avail­abil­ity of ben­e­fits, re­duc­tions in the abil­ity to bor­row (es­pe­cially against hous­ing), and a greater ac­cu­mu­la­tion of as­sets by for­eign cen­tral banks and sov­er­eign wealth funds. Re­duced in­vest­ment has been driven by slower growth in the labour force, the avail­abil­ity of cheaper cap­i­tal goods, and tighter credit (with lend­ing more highly reg­u­lated than be­fore)."

Stem­ming from his di­ag­no­sis of the global econ­omy's cur­rent woes, Sum­mers' pol­icy pre­scrip­tion is a re­turn to the cen­tral­ity of fis­cal pol­icy, which has been ne­glected as of late. For a decade and a half be­fore the fi­nan­cial cri­sis, the con­sen­sus view in the eco­nom­ics pro­fes­sion was that mon­e­tary pol­icy, as de­liv­ered through in­fla­tion tar­get­ing, would suf­fice to fine-tune the econ­omy and keep it close to its long-run po­ten­tial level of out­put and em­ploy­ment, while at the same time overcoming, or at least mit­i­gat­ing, the ebb and flow of the busi­ness cy­cle.

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