PIMCO boss Mohamed El-Erian will no doubt soon be granted a trademark on “The New Normal.” In the meantime, in PIMCO’s latest outlook, he explains in detail what it means.
In a word?
But if that’s depressing, take a look at the recent trends (below), and thank heaven it’s not worse.
First, the good news:
Policymakers are fully engaged in an effort to avoid another Great Depression. The secular forces of productivity gains and entrepreneurial dynamism will not disappear. And there are pockets of considerable economic and social flexibility, high self-insurance, and even some global policy coordination.
Now, the bad news:
Yet, while these factors help reduce the risk of a deflationary depression, they are not strong enough for a return to the high growth and low inflation that characterised 2002–07. Simply put, there are insufficient demand buffers and fast-acting structural reforms to provide for a spontaneous and sustainable recovery in the global economy.
No wonder we have characterised the financial crisis as a crisis of the global system (as opposed to a crisis within the system). Lacking endogenous circuit breakers, the system will not reset quickly and without permanent changes (and some would argue that even if it could, it should not). For markets that are highly conditioned by the most recent periods of “normality,” this will feel like a new normal. Indeed, it will be a major shock to those that are trapped by an overly dominant “business-as-usual” mentality.
The New Normal
For the next 3–5 years, we expect a world of muted growth, in the context of a continuing shift away from the G-3 and toward the systemically important emerging economies, led by China. It is a world where the public sector overstays as a provider of goods that belong in the private sector. (As one of our speakers put it, we have transitioned from a world where the private sector provided public goods to one where the public sector provides private goods.) It is also a world in which central banks and treasuries will find it difficult to undo smoothly some of the recent emergency steps. This is particularly consequential in countries, such as the U.K. and U.S., where many short-term policy imperatives materially conflict with medium-term ones.
The banking system will be a shadow of its former self. With regulation more expansive in form and reach, the sector will be de-risked, de-levered, and subject to greater burden sharing. The forces of consolidation and shrinkage will spread beyond banks, impacting a host of non-bank financial institutions as well as the investment management industry.
How does inflation behave in the new normal? For now, it is hard to project any imminent pickup in inflation given the severity of the collapse in global demand and the resulting large output gap. Private components of global demand will not recover quickly and fully. Yet, one should not fixate just on demand when transitioning from a cyclical to a secular mindset. Supply also matters.
In the next few years, the historical pace of growth in potential output will face many headwinds. Excessive regulation, higher taxation, and government intervention will be among the factors that will constrain the growth of potential (non-inflationary) output (Chart 3, prepared by Ramin Toloui, conceptualizes the process). With investment activity subdued for a while, the rate of depletion of the capital stock will rise. There is also the loss of endogenous credit factories that, especially in their overheated 2004–07 phases, fooled people into believing that the increase in leverage-based economic activities was sustainable…
Think of the following potential configuration:
- We would look for financial rehabilitation in the U.S. to occur in the context of low growth and an eventual inflationary bias down the road.
- The U.K. would also be stuck in a low growth world, but with greater vulnerability to domestic and/or external financial instability.
- Core Europe will also grow slowly, influenced by its historical inflation phobia and concerns for the integrity of the European Union.
- Japan will continue to face growth headwinds as its economy is too encumbered by fiscal and demographic issues.
- Emerging economies will bifurcate more clearly into two groups. Those with weak initial conditions will return to the old emerging market paradigm that alternates between austerity and financial instability; those with strong initial conditions will maintain their development breakout phase, albeit not at the torrid pace of recent years.
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