Tue, Oct 04, 2016 - Page 9 News List

Escaping the ‘new normal’ of weak global economic growth

By Michael Spence

There is no question that the recovery from the global recession triggered by the 2008 financial crisis has been unusually lengthy and anemic. Some still expect an upswing in growth. However, eight years after the crisis erupted, what the global economy is experiencing is starting to look less like a slow recovery than like a new, low-growth equilibrium. Why is this happening, and is there anything we can do about it?

One potential explanation for this “new normal” that has gotten a lot of attention is declining productivity growth. However, despite considerable data and analyses, productivity’s role in the current malaise has been difficult to pin down and, in fact, seems not to be as pivotal as many think.

Of course, slowing productivity growth is not good for longer-term economic performance and it might be among the forces holding back the US as it approaches “full” employment. However, in much of the rest of the world, other factors — namely, inadequate aggregate demand and significant output gaps, rooted in excess capacity and underused assets, including people — seem more important.

For example, in the eurozone aggregate demand in many member countries has been constrained by, among other things, Germany’s large current-account surplus, which last year amounted to 8.5 percent of its GDP. With higher aggregate demand and more efficient use of existing human capital and other resources, economies could achieve a significant boost in medium-term growth, even without productivity gains.

None of this is to say that we should ignore the productivity challenge, but the truth is that productivity is not the principal economic problem right now.

Tackling the most urgent problems confronting the world economy will require action by multiple actors — not just central banks. Yet, thus far, monetary authorities have shouldered much of the burden of the crisis response. First, they intervened to prevent the financial system’s collapse, and, later, to stop a sovereign debt and banking crisis in Europe. Then they continued to suppress interest rates and the yield curve, elevating asset prices, which boosted demand via wealth effects.


However, this approach, despite doing some good, has run its course. Ultra-low — even negative — interest rates have failed to restore aggregate demand or stimulate investment. And the exchange-rate transmission channel will not do much good, because it does not augment aggregate demand; it just shifts demand around among countries’ tradable sectors. Inflation would help, but even the most expansionary monetary measures have been struggling to raise inflation to targets, Japan being a case in point. One reason for this is inadequate aggregate demand.

Monetary policy should never have been expected to shift economies to a sustainably higher growth trajectory by itself. And, in fact, it was not: Monetary policy was explicitly intended to buy time for households, the financial sector, and sovereigns to repair their balance sheets and for growth-enhancing policies to kick in.

Unfortunately, governments did not go nearly far enough in pursuing complementary fiscal and structural responses. One reason is that fiscal authorities in many countries — particularly in Japan and parts of Europe — have been constrained by high sovereign debt levels. Furthermore, in a low interest-rate environment, they can live with debt overhangs.

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