Are the U.S. and Europe suffering from more than the aftermath of a major financial crisis? Might they be stuck in an unusual and prolonged equilibrium, in which frustratingly slow economic growth is the norm?
These are the crucial questions addressed in a new e-book from the Center for Economic Policy Research that I would recommend to policy makers, academics and investors alike.
Back in 2009, when I was working at the investment company Pimco, my colleagues and I argued that economic growth in the West would fail to bounce back sharply, as it typically does after a crisis-induced downturn. Instead, Western economies would face unusually sluggish growth and persistently high unemployment. We called it the “new normal.” The notion was initially dismissed by many as “unrealistic” and then as too “fatalistic.”
Now the idea is being reinforced in a major way under the moniker “secular stagnation” — brought to public awareness by the Harvard University economist Larry Summers. In the book, the CEPR brings together respected economists from different schools of thought — including Summers, Paul Krugman and Barry Eichengreen — to discuss the various possible explanations, which tend to involve three elements:
Structural headwinds from aging populations, poor infrastructure, heavy debt burdens, slow productivity growth and inequality;
Demand that is poorly distributed around the world and in many cases inadequate as people channel money toward paying down debt instead of spending; and
A "sclerosis" effect in the labor market as persistent unemployment erodes skills and youth joblessness threatens to create a lost generation.
One disturbing finding is that policy measures such as central-bank stimulus may be ineffective in simultaneously delivering high growth, robust job creation, price stability and financial soundness. As Summers puts it, if the macroeconomic goals are attained, "there is likely to be a price paid in terms of financial stability.”
Given the enormous stakes for current and future generations, the book rightly argues that serious thinking should be devoted to developing alternative policies. These involve pro-growth initiatives such as investing in education and infrastructure — ideas that have broad support among economists but have been stymied by political dysfunction. A second part looks at more controversial proposals for economic rethinks and institutional revamps, such as increasing central banks' inflation targets or raising the retirement age.
Even today, there are people who believe that Western economies are suffering just from flesh wounds. Others feel that the ongoing period of gradual healing will prove sufficient to achieve economic liftoff, supported by the steadfast policies of central banks. Only a minority believe that something more worrisome may be in play, which is why the CEPR's contribution is so important.
Hopefully, by demonstrating why new economic thinking is needed, the book will raise awareness and catalyze innovative analysis. In any case, the work is extremely relevant to markets, where much of today’s pricing seems to assume that the old thinking is still valid.
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