Has the West entered secular stagnation? Results from the Centre for Macroeconomics October survey

Angus Armstrong, Francesco Caselli, Jagjit Chadha, Wouter den Haan

Have Western economies entered a period of secular stagnation? Among respondents to the latest monthly survey of the Centre for Macroeconomics (CFM), reported in this column, three out of four think not – though, on balance, they feel that policy ought to be more expansionary anyway. Several panel members question whether secular stagnation is a useful and well-defined concept, yet despite this ambivalence, the number of CFM experts who think that policies should be more concerned about low real interest rates is substantially higher than the number that do not.

The Centre for Macroeconomics (CFM) – an ESRC-funded research partnership between the University of Cambridge, the London School of Economics (LSE), University College London (UCL), the Bank of England and the National Institute of Economic and Social Research (NIESR) – is today publishing the results of its monthly survey. The survey aims to inform the public about the views held by leading UK-based macroeconomists on important questions about macroeconomics and public policy.

This month’s questions concern the revival of interest in the idea of secular stagnation. The survey was conducted in the last week of September. A full list of written responses from our panel of experts can be found here.1 Only 25% (27% if we weigh by confidence) of respondents think that the Western economies have entered a period of secular stagnation. Indeed, several panel members question whether secular stagnation is a useful and well-defined concept and this may explain the lack of strong views on either side. Despite some ambivalence to the idea of secular stagnation, the number of respondents who think that policies should be more concerned about low real interest rates is substantially higher than the number that do not.

The idea of secular stagnation

Over seven years since the collapse of the interbank market and nearly six years after the collapse of Lehman Brothers, the global financial crisis is still with us and the recovery does not quite seem secure. Despite years of extraordinarily low policy interest rates, increases in public debt and unconventional monetary policies, few advanced economies have secured the kind of growth that characterised the post-war growth experience. Larry Summers (2013) has suggested that the lack of response to these policy stimuli might imply that a secular stagflation may have taken hold.2

For this month’s CFM survey, we provided a simple outline of what we think the hypothesis entails and then first asked respondents to consider whether they thought the major advanced economies (the US, the UK and the euro area) have recently entered a phase of secular stagnation.3 We then asked respondents to give an opinion on whether the natural rate of interest is currently negative and thus whether further policy stimulus is required.

The exact definition of secular stagnation is not entirely clear. Alvin Hansen coined the term in his presidential address to the American Economic Association in 1938 to describe a prolonged period of low growth and high unemployment, with no self-correcting mechanism to return the economy to full employment and rapid growth. And the latter-day symptoms would seem to involve sluggish economic growth, as well as large output gaps and below target rates of inflation following the economic crisis. The poor performance of the real side of the economy has left economies vulnerable to further problems induced by persistently low, and possibly falling, real rates of return that have distorted financial balance sheets and left the financial sector prone to asset price bubbles.

In their recent collection of papers, Coen Teulings and Richard Baldwin (2014) suggested three implications of secular stagnation:

Secular stagnation implies that negative real rates are required to bring savings and investment to clear at full employment. The appearance of secular stagnation makes it especially hard to achieve full employment when there is both low inflation and a binding zero lower bound on policy rates. An immediate need for economists and policy-makers to start dealing with secular stagnation by adopting more expansionary policies.

Q1: Do you agree – making your own definition of secular stagnation clear if you disagree with that offered here – that it is more likely than not that the advanced Western economies have entered into a period of secular stagnation?

Summary of responses

Respondents tend to agree with the observable fact that real rates have trended down but the consensus among the respondents mostly breaks down at that point. Many, for instance, do not like the basic concept of secular stagnation. Morten Ravn (UCL), for example, says ‘I prefer to refer to secular stagnation simply as a very long recession’; and Patrick Minford (Cardiff) goes further: ‘The definition is confused. It is either stating that there is a ‘demand problem’ (such as a failure of the monetary and credit system) or that there is a ‘productivity/supply problem’ (such as distortions in the labour market, lack of competitive entry into industry, regulative obstacles).’ And some, such as Angus Armstrong (NIESR) place other reasons than secular stagnation as an explanation: ‘I suspect that private balance sheets and the unreconstructed financial sector are central to the stagnation.’

The complexity of the issues under consideration is outlined by Luis Garicano (LSE): ‘There are also clear demographic headwinds that will continue to reduce employment rates. The demographic component is undeniably secular, the TFP part may or may not be, depending on future technological gains. Thus I agree there are substantial reasons to think that the capacity of the economy to grow is likely lower than in the past, and this is likely to be persistent. I do not agree however we are in a phase of demand-side secular stagnation in the sense of permanent below potential growth.’

The natural rate of interest

One key aspect of the secular stagnation hypothesis is that the natural rate of interest, which equates savings and investment at full employment, may have become negative. The long-run decline in real rates has been variously explained by the growth of emerging economies that run large external surpluses, which add to the pool of global savings, as well as a collapse in the demand for loanable funds by the fast-growing IT sector, the effects of population ageing and increasing demand for safe assets.

It is hard for some economists to accept that natural rates are negative as that implies a negative rate of time preference in a representative agent model,4 as well as a lack of positive investment opportunities. But if the natural rate is negative then expansionary policies – whether structural or fiscal – may help push the natural rate back into the territory that can be managed by orthodox monetary policies.

Q2: Do you think that current structural and fiscal policies should place a considerably greater emphasis on pushing the natural rate into positive territory?

Summary of responses

Some respondents feel that there ought to be more expansionary policy whether or not there is a secular stagnation. Simon Wren-Lewis (Oxford) writes ‘An unusual degree of fiscal contraction has caused a slow recovery in the US, a delayed recovery in the UK, and a second recession in the Eurozone. This is all unnecessary and damaging, and so should be reversed, whether we have secular stagnation or not.’ But even some of those who agree remain cautious – Costas Milas (Liverpool), for example, says ‘I agree with reference to structural policies. We need to be cautious in terms of how expansionary fiscal policy needs to be as this should be conditional on whether the budget deficit-to-GDP ratio and/or the debt-to-GDP ratio is sufficiently low.’

In a similar vein but with disagreement in mind, Jagjit Chadha (Kent) says ‘there is probably always room for more structural reform but it should not target a particular rate of return. Fiscal policy may have some role to play in infrastructure investment but in many countries, with the exception of Germany, there is not much room for manoeuvre.’ And Marco Bassetto (UCL) outlines another argument: ‘I believe that the very low real interest rates that we are experiencing follow from disruptions in financial markets. The best way for the government to help is to provide a clear and transparent regulatory environment, stable rules of the game, and to ensure that its own credibility as a debtor is sustained. Running big deficits is incompatible with this credibility.’

Furthermore, Silvana Tenreyro (LSE) argues ‘The natural rate of interest per se should not be a target for structural or fiscal policy (for one, it is difficult to measure!); unemployment and other labour market variables – among others – are more informative and relevant indicators to guide policy actions.’

References

Hansen, Alvin (1938), Speech published as A H Hansen (1939), “Economic Progress and Declining Population Growth”, American Economic Review, 29: 1–15.

Summers, Larry (2013) ‘Why stagnation may prove to be the new normal’.

Teulings, Coen and Richard Baldwin (2014) ‘Secular stagnation: Facts, causes, and cures’, a VoxEU ebook.

[1] http://www.cfmsurvey.org

[2] Even Summers may have had second thoughts: http://www.ft.com/cms/s/2/4be87390-352a-11e4-aa47-00144feabdc0.html#axzz3E8EyT1Xb

[3] Japan may be considered a precursor but we suggest concentrating on Western economies in this analysis.

[4] See Simon Wren-Lewis for an explanation of how this observation may change in an overlapping generations framework: http://mainlymacro.blogspot.co.uk/2014/04/secular-stagnation-and-three-period-olg.html