News: The probability of recession has increased since the beginning of the year for several economies. In this context, several analyses warn of a risk of secular stagnation that would limit the possibility of further lowering already negative rates.
Secular stagnation is not a new idea, as it was first theorized by Alvin Hansen, a disciple of John Maynard Keynes, in the 1930s. Hansen believed that a simultaneous erosion of population growth and technological progress reduced investment opportunities. Private savings would therefore find no outlet unless the government implemented stimulus policies to reinvigorate demand.
Due to the strong growth rates observed after World War II, the theory was largely forgotten until Lawrence Summers, an economist at Harvard, revived it in 2013 (see a previous BSI Economics article on the subject). He suggests that developed countries are entering a period of secular stagnation.
According to proponents of this theory, several factors must be taken into account when assessing an economy’s growth potential:
– demographics, as a country’s potential output depends on the number of workers available and their productivity;
– the level of inequality, as the wealthiest individuals tend to consume less than the poorest, and a high level of inequality tends to reduce consumption (see this BSI Economics article for more details), and therefore growth.
However, in developed countries, population growth is indeed low (the German population is expected to decline in the coming decades, the British population is expected to remain stable, and the US population is expected to grow very slowly), inequality is rising, and real wages are stagnating. All these factors combined have led to a significant decline in interest rates, as private savings find few investment opportunities in the economy.
According to Lawrence Summers and proponents of secular stagnation theory, these factors show that developed countries will not be able to return to high levels of growth.
Excessively negative real interest rates and low inflation would lead to secular stagnation
One way to stimulate economic activity through private demand is to lower the real interest rate (nominal interest rate minus inflation). However, this option is limited if inflation is too low or even negative (due, for example, to excess production capacity). A reduction in the nominal interest rate is then necessary to allow the real interest rate to be sufficiently low.
However, lowering the nominal interest rate to a negative level is difficult to implement due to legal constraints (in the United States) or already negative nominal rates, which could further reduce the profitability of the banking system. Too low inflation coupled with already too negative real yields could lead to secular stagnation.
Furthermore, the implementation of such a policy could lead to significantspillovers, as observed in emerging markets when accommodative monetary policies were implemented by central banks in developed countries (mainly the Fed).
Lowering key rates and therefore interest rates encourages private savers to seek profitable opportunities, particularly in emerging countries. These capital movements can fuel financial bubbles in emerging countries and contribute to increased financial volatility in these countries.
Four arguments that reject the risk of secular stagnation resulting from the rigidity of negative rates
1. Deflationary pressures remain contained across all economies, making it impossible to identify any secular stagnation. Food and energy prices should even reduce their negative contribution, while wages continue to rise moderately in the United Kingdom and the United States.
2. The United States and Japan are not in a situation of overproduction. Neither are any other developed countries.
3. However, one of the necessary conditions for secular stagnation would be overproduction financed by excessive debt. This condition is therefore not currently met in developed countries.
4. Real interest rates remain below the growth rates in Japan and the United States. They are also below the equilibrium interest rate, even if the latter were to be around 0.
Conclusion
Far from being a reality, Lawrence Summers’ theory of secular stagnation nevertheless highlights the difficulties currently facing the global economy. While growth has been slow to pick up in developed countries since the 2008 financial crisis, and the question now arises as to whether central banks need to apply negative policy rates, the conditions necessary to identify secular stagnation do not seem to be in place in developed countries.
Written by Thomas Lorans
Reference: « Why stagnation might prove to be the new normal, » Lawrence Summers, Financial Times, 2013
