Editor’s Note: Business Insider reached out to Mohamed for an update on the New Normal. Here is what he sent us in response.
The context: When first rolled out in a May 2009 PIMCO publication, the concept of the “new normal” attracted only limited support in economic, market and policy circles. But after five years of frustratingly-low economic growth and alarmingly-high unemployment, the concept has caught on. It also relates to the more-detailed analytical work done by Carmen Reinhard, Ken Rogoff, Larry Summers, Paul Krugman, Richard Koo, Tom Friedman, and others.
What is the new normal: Developed over several rounds of discussions among PIMCO colleagues in the run-up and the immediate aftermath of the 2008 global financial crisis, the concept signaled the likelihood that western economies would not reset in a typical cyclical manner – or, adapting an old Monty Python sketch, the crisis would prove much more than a “flesh wound.” Rather than a quick bounce back in growth (the rubber band “V” shaped recovery), economic activity would remain persistently sluggish and unemployment unusually high.
The underlying rationale: The initial reasoning was based on the view that it takes many years for an economy to recover fully from a period of excessive leverage, extreme debt entitlement, and irresponsible risk taking and credit extension. Subsequently, with policy responses lagging developments on the ground (see next point), the growth/employment challenges were further aggravated by inadequate aggregate demand and insufficient attention paid to supply-side factors.
Policy concerns: While policymakers did respond boldly using extraordinary measures, their initial reactions underestimated the depth of the crisis. Too many of them struggled to combine a cyclical mindset (which, prior to the crisis, had served them well), with a more secular and structural one. They also dismissed way too quickly the notion that western economies can learn a few things from the experience of the emerging world. When the new normal realisation finally set in, the political context was no longer conducive to a comprehensive policy response. As a result, central banks have had to carry the bulk of the policy burden; and have done so using – inevitably – imperfect tools.
The impact on Main Street: It has been devastating, harming both current and future generations. Just witness the extent of long-term joblessness and youth unemployment, as well as the excessive increase in the inequality trio (of income, wealth and opportunities). It has also contributed to political polarisation and weakened global policy coordination on economic and geo-political issues.
The impact on Wall Street: Here the impact has been quite subdued. Thanks to the hyper activism of central banks, markets have been largely shielded from the impact of weaker fundamentals. Indeed, central banks have inserted quite a wedge between fundamentals and market prices; and they have done so for an understandable reason: given their limited policy tools, they are obliged to use the asset price channel as a way to influence wealth, spending, animal spirits, risk taking and investing.
The economic outlook: Over the short-term, the economic baseline calls essentially for more of the same, along with fatter two-sided tails for the distribution as a whole. Specifically, absent major policy mistakes or geo-political/market accidents, western growth will gradually improve in 2014, but unfortunately still fall short of escape velocity. Over the medium-term, however, the probability of tipping into one of the two tails is likely to increase: so either the west reaches a critical point of internal healing that enables growth at or above potential for a while; or now-deeply embedded structural problems contribute to more prolonged low growth with significantly higher probability of financial volatility.
The intrigue: As yet, there is simply not enough data and analytical underpinning to predict with confidence which of the two-tails would ultimately dominate.
Mohamed A. El-Erian is the former CEO/co-CIO of PIMCO. He is Chief Economic Advisor at Allianz and member of its International Executive Committee, Chair of President Obama’s Global Development Council and author of the NYT/WSJ bestseller “When Markets Collide.”
Follow him on twitter @elerianm
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