Is America stuck in a rut of low growth, feeble inflation and rock-bottom interest rates? Lots of economists believe in the idea of “secular stagnation”, and they have plenty of evidence to point to. The population is ageing and long-run growth prospects look dim. Interest rates, which have been near zero for years, are still not low enough to get the American economy zipping along.
A new paper published by the University of Chicago’s Booth School of Business, however, reckons that secular stagnation is not quite the right diagnosis for America’s ills.*
A country in the grip of secular stagnation cannot find enough good investments to soak up available savings. The drain on demand from these underused savings leads to weak growth. It also leaves central banks in a bind.
If the real (ie inflation adjusted) “equilibrium” interest rate (the one that gets an economy growing at a healthy clip) falls well below zero, then central bankers will struggle to push their policy rate low enough to drag the economy out of trouble, since it is hard to push nominal (ie, not adjusted for inflation) rates deep into negative territory.
Worse, in the process of trying, they may end up inflating financial bubbles, which lead to unsustainable growth and grisly busts.
Stagnationists argue that this is not a bad description of America since the 1980s. Real interest rates have been falling for years, they note, a sign of a glut of savings. Recoveries from recent recessions have been weak and jobless. When growth has perked up, soaring asset prices and consumer borrowing appear to have done the heavy lifting.
The authors of the Chicago paper–James Hamilton, Ethan Harris, Jan Hatzius and Kenneth West–dispute this interpretation of events. Stagnationists are right, they note, that real interest rates have been falling, and have in fact been negative for much of the past 15 years. But low real rates do not necessarily imply that future growth will be weak, as many economic models assume.
The authors examine central-bank interest rates, inflation and growth in 20 countries over 40 years. They find at best a weak relationship between economic growth and the equilibrium rate. If there is a long-run link, they argue, it tends to be overshadowed by other factors.
After the second world war, for example, government controls on rates (“financial repression”) prevented the market from having its say. In recent years short-run woes have dragged down the equilibrium rate, such as the “50-miles-per-hour headwinds” that Alan Greenspan, the chairman of the Federal Reserve, described in 1991, when bad loans pushed big American banks to the brink of insolvency. The authors note that such stormy periods are usually short-lived, and that when the headwinds abate the equilibrium rate tends to pop back up.
They also reckon the stagnationists are misinterpreting some of the evidence. Growth in the 1990s was not illusory, they argue. The stockmarket boom only really got going in 1998, after America’s unemployment rate had already fallen below 5%.
The expansion of the 2000s looks like a better example of secular stagnation. Investment in housing, which rose from 4.9% of GDP in 2001 to 6.6% at the market’s peak in 2006, helped sustain the boom. Rising house prices made Americans feel flush, propelling consumer spending. Expanding credit added about one percentage point to growth each year, says the paper.
Yet the behaviour of the economy in this period looks more like a product of distortion than stagnation. At the time China and oil-producing states were running enormous current-account surpluses with America and building up large foreign-exchange reserves, contributing to what Ben Bernanke, Mr Greenspan’s successor as Fed chairman, labelled a “global saving glut”. Expensive oil and rising Chinese imports placed a drag on growth that more or less offset the boost from housing. Take away the savings glut and the housing boom, and the American economy would not necessarily have grown any faster or slower, just more healthily.
What about the situation now? Some of the distorting forces of recent years are slowly fading. Household finances are certainly in better shape after a long period of deleveraging. That is helping to power a consumer-driven recovery in America that will eventually lead to higher interest rates.
On the other hand, stagnationists argue that the effects of demographic change are intensifying. Baby-boomers approaching retirement may be stashing more money away. Longer lifespans continue to spur saving. Axel Gottfries and Coen Teulings of Cambridge University have found that the increase in life expectancy over the past 40 years in rich and middle-income countries has raised the desired stock of savings by two times GDP.
Global conditions must also be taken into consideration. The authors of the Chicago paper calculate that over the long term, America’s real interest rate tracks the one prevailing across the world as a whole (see chart). Yet since about 2000 the real rate in America has generally been well below that of the world as a whole. The authors argue that thanks to the mobility of international capital that gap should soon close (albeit in part because global rates will probably fall).
On their best estimates America’s equilibrium rate has probably fallen a little, relative to the average from the 1960s until 2007 of about 2%. But, they argue, the decline is smaller than many stagnationists believe, and the rate is almost certainly positive. Nor is a lower rate now a sign that growth will permanently fall below past averages.
That is still no reason to breathe easy. A low equilibrium rate raises the risk that central-bank interest rates will sometimes become stuck at zero, leaving an economy in a prolonged slump. Even if the risk of secular stagnation is overdone, the authors reckon that the Fed has good reason not to raise rates too soon.
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