THE END OF THE NEW NORMAL?

If policymakers implement a comprehensive response, their economies will be on a more stable & prosperous path

If policymakers implement a comprehensive response, their economies will be on a more stable & prosperous path

Just when the notion that Wester n economies are settling into a “new nor mal” of low g rowth gained mainstream acceptance, doubts about its continued relevance have be gun to emerge. Instead, the world may be headed toward an economic and financial crossroads, with the direction taken depending on key policy decisions.

In the early days of 2009, the “new nor mal” was on virtually no one’s radar. Of course, the global financial crisis that had erupted a few months earlier threw the world economy into tur moil, causing output to contract, unemployment to surge, and trade to collapse. Dysfunction was evident in even the most stable and sophisticated segments of financial markets.

Yet most people’s instinct was to characterise the shock as temporary and reversible—a V-shape disruption, featuring a sharp downtur n and a rapid recovery. After all, the crisis had originated in the advanced economies, which are accustomed to managing business cycles, rather than in the emerging-market countries, where structural and secular forces dominate.

But some observers already saw signs that this shock would prove more consequential, with the advanced economies finding themselves locked into a frustrating and unusual long-ter m low-growth trajectory. In May 2009, my PIMCO colleagues and I went public with this hypothesis, calling it the “new nor mal.”

The concept received a rather frosty reception in academic and policy circles—an understandable response, given strong conditioning to think and act cyclically. Few were ready to admit that the advanced economies had bet the far m on the wrong growth model, much less that they should look to the emerging economies for insight into structural impediments to growth, including debt overhangs and excessive inequalities.

But the economy was not bouncing back. On the contrary, not only did slow growth and high unemployment persist for years, but the inequality trifecta (income, wealth, and opportunity) worsened as well. The consequences extended beyond economics and finance, straining regional political arrangements, amplifying national political dysfunction, and fuelling the rise of anti-establishment parties and movements.

With the expectation of a V-shape recovery increasingly difficult to justify, the “new nor mal” finally gained widespread acceptance. In the process, it acquired some new labels. Inter national Monetary Fund Managing Director Christine Lagarde war ned in October 2014 that the advanced economies were facing a “new mediocre”. For mer US Secretary of the Treasury Larry Summers foresaw an era of “secular stagnation”.

Today, it is no longer unusual to suggest that the West could linger in a lowlevel growth equilibrium for an unusually prolonged period. Yet, as I explain in my new book The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse, growing inter nal tensions and contradictions, together with overreliance on monetary policy, are destabilising that equilibrium.

Indeed, with financial bubbles growing, the nature of financial risk morphing, inequality worsening, and non-traditional—and in some cases, extreme—political forces continuing to gain traction, the calming influence of unconventional monetary policies is being stretched to its limits. The prospect that such policies will be able to keep the economic engines humming, even at low levels, looks increasingly dim. Instead, the world economy seems to be headed for another crossroads, which I expect it to reach within the next three years.

This may not be a bad thing. If policymakers implement a more comprehensive response, they can put their economies on a more stable and prosperous path—one of high inclusive growth, declining inequality, and genuine financial stability. Such a policy response would have to include pro-growth structural refor ms (such as higher infrastructure investment, a tax overhaul, and labour retooling), more responsive fiscal policy, relief for pockets of excessive indebtedness, and improved global coordination. This, together with technological innovations and the deployment of sidelined corporate cash, would unleash productive capacity, producing faster and more inclusive growth, while validating asset prices, which are now artificially elevated.

The alter nate path, onto which continued political dysfunction would push the world, leads through a thicket of parochial and uncoordinated policies to economic recession, g reater inequality, and severe financial instability. Beyond har ming the economic well-being of current and future generations, this outcome would under mine social and political cohesion.

There is nothing pre-destined about which of these two paths will be taken. Indeed, as it stands, the choice is frustratingly impossible to predict. But in the coming months, as policymakers face intensifying financial volatility, we will see some clues concer ning how things will play out.

The hope is that they point to a more systematic—and thus effective—policy approach. The fear is that policies will fail to pivot away from excessive reliance on central banks, and end up looking back to the new nor mal, with all of its limitations and frustrations, as a period of relative calm and wellbeing.

Such a policy response would have to include pro-growth structural reforms (such as higher infrastructure investment, a tax overhaul, and labour retooling), more responsive fiscal policy, relief for pockets of excessive indebtedness, and improved global coordination