Saturday, April 19, 2014
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The Looming Lost Decade

PRINCETON – As 2013 comes to an end, it looks like the world economy will remain stuck in low gear. For those reading the tea leaves of global recovery, the third-quarter GDP numbers offered no solace. While the United States is ahead of the pack, some of its gains could soon be lost, as accumulating inventories begin eroding profits. Despite glimmers of hope, the eurozone and Japan are struggling to cross the 1% threshold for annual economic growth. And the major emerging economies are all slowing, with Russia practically at a standstill.

Not surprisingly, a catchphrase in economic-policy debates nowadays is “secular stagnation,” the idea that excess savings chronically dampen demand. The economist Robert Gordon has also argued that the world is low on economically productive ideas.

But before we despair, there is work to be done. The coordinated fiscal stimulus that saved the world from economic collapse in 2009 disappeared too quickly, with governments shifting their focus to domestic politics and priorities. As domestic policy options have been exhausted, economic prospects have dimmed. A renewed emphasis on stimulus must be augmented by global coordination on the timing and content of stimulus measures.

The crisis was and remains global. Trade data tell the story: after increasing by about 7% annually in the decade before 2008, world trade fell faster than global GDP in 2009 (and more sharply than during the Great Depression). Once the brief stimulus-fueled recovery faded, growth in world trade again slowed quickly, falling to 2% year on year over the past 18 months. Disappointing export performance is largely responsible for the recent weakening of economic-growth prospects.

At the end of 2008, when the scale of the impending economic destruction was not yet apparent, Olivier Blanchard, the International Monetary Fund’s chief economist, boldly called for a global fiscal stimulus, stating that, in these “not normal times,” the IMF’s usual advice – fiscal retrenchment and public-debt reduction – did not apply. He warned that if the international community did not come together, “vicious cycles” of deflation, liquidity traps, and increasingly pessimistic expectations could take hold.

Fortunately, world leaders listened, agreeing in April 2009 at the G-20 Summit in London to provide a total of $5 trillion in fiscal stimulus. The US and Germany added stimulus amounting to about 2% of GDP. And China’s banks pumped massive amounts of credit into the country’s economy, enabling it to sustain import demand, which was critical to the global recovery.

But hubris rapidly set in, and parochial interests took over. Before the wounds had fully healed, the treatment was terminated.

The worst offenders were the US and Germany, which shirked the responsibility to protect the global common good that accompanies their status as economic hegemons. The United Kingdom, with its contrived rationale for fiscal austerity, was not much better. Fiscal stimulus by these three countries – together with smaller contributions from France and China – could have continued the necessary healing.

Countries now seem to think that monetary-policy measures are their only option. But, whereas fiscal stimulus boosts growth at home and abroad, enabling mutual reinforcement through world trade, monetary policy is guided primarily by domestic goals, and, in the short term, one country’s gain can be another’s loss.

America leads the world in monetary-policy ambition. The researchers Cynthia Wu and Fan Dora Xia estimate that the US Federal Reserve’s open-ended asset purchases (so-called quantitative easing, or QE) have led to an effective US policy rate of -1.6%. QE helped American exports by weakening the dollar relative to other currencies. Once the Japanese engineered their own QE, the yen promptly depreciated. That has kept the euro strong.

The weakest of the “big three” developed economies – the eurozone – has thus been left with the strongest currency. In the third quarter of 2013, Germany’s export growth slowed and French exports fell. After a spike earlier in the year, Japan’s exports have also contracted. Only US exports have maintained some traction, thanks to the weaker dollar.

In the 1930’s, after the gold standard broke down, world leaders could not agree on coordinated reflation of the global economy. In his book Golden Fetters, the economist Barry Eichengreen argued that the lack of coordinated action dragged out the global recovery process. Such delays are costly, and risk allowing pathologies to fester, prolonging the healing process further.

Now, despite unfavorable political circumstances, Blanchard should make an even bolder call. These are still not “normal” times, and the “vicious cycles” persist. Another global fiscal stimulus – focused on public investment in infrastructure and education – would deliver the adrenaline shot needed for a robust recovery.

More public investment is twice blessed. It can shake the world out of its stupor; and it can safeguard against “secular stagnation.” The US, Germany, the United Kingdom, France, and China should act together to provide that boost. Otherwise, a sustainable global recovery may remain elusive, in which case 2014 could end in low gear as well.

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  1. CommentedAlex Bauboin

    I don't understand why everyone is always saying that Quantitative Easing is sort of a 'beggar-thy-neighbor' policy. I'm not the biggest fan of QE, but it's not. Even if the main effect of QE is devaluation, the money is going somewhere and increasing the money supply there. If everyone tries to competitively devalue through QE, it won't change the exchange rates, but it will still increase overall money supply and move the real exchange rate into negative territory.

    1. CommentedAlex Bauboin

      I mean the real interest rate. .. And negative real interest rates not only spur investments, but also help deleveraging and redistributing from creditors to debtors, so that the whole show may begin again afterwards.

  2. CommentedPaul Mathew Mathew

    When reading this article I had to check if the author was Paul Krugman - because as we know his mantra is more stimulus - just a little more.

    Are you aware Mody - that China has pumped 15 trillion dollars of new cash out since 2009? If you were to read Zero Hedge you would know that

    So you say central banks stopped prematurely and that is why we are faltering.

    Here's some news for you - we have been using debt (and now printing) to escape the jaws of deflation and collapse - for years now - and that trick no longer works.

    Everyone is up to their ears in debt - so debt based growth is done. That is why countries are printing - this is the last desperate gasp - before utter collapse.

    You are failing to see the big picture - our growth paradigm was based on cheap fossil fuels. That era is over. We have plucked the low hanging fruit.

    The best research to date that I have seen on the impact of high energy costs is here - and it is not pretty

  3. CommentedJohn McDonald

    For hundreds of years people have been saying that further growth is just not possible.

    1. CommentedPaul Mathew Mathew

      Have a look at this research:

  4. CommentedEdward Ponderer

    It is troubling when people model and don't look to boundary conditions that when confronted, change not merely the specific characteristic values of the equation, but change the nature of the equation altogether. At some point, the physicist must play the engineer and realize that Hook's law of proportional restoration force will not apply beyond the point the rubber band snaps. Well dear economists--the rubber band of limitless growth on a closed sphere is about to snap.

  5. CommentedTim Chambers

    What is necessary is to rethink what profits are for. Are they for hoarding by robber barons, as they were In feudal times, or to maximize social utility, in accordance with enlightenment principles? There would be no talk of lost decades if everyone had money to spend because profits were widely disbursed. Even in feudal times we had the myth of St. George and the dragon. The dragon then was the decadent aristocracy, sitting on its pile of gold and jewels, incinerating with its fiery breath anyone who would challenge its right to possess all the wealth. Today, it is the corporations and the banks who sit atop a pile of lucre and the media are the dragon's breath.

    The example of Japan is instructive. Despite its lost decades since the bubble, its corporations still provide plenty of jobs for new graduates, and profit sharing for its employees, because the law requires it. Life, for most people, isn't perhaps as easy as it was in the high growth years, but neither does much of its populace struggle with poverty and permanent unemployment.

    Where is Saint George when we need him?

  6. CommentedZsolt Hermann

    The article highlights two fundamental principles we keep ignoring:
    1. Constant Growth
    We stubbornly ignore the facts that in a closed and finite natural system such thing as continuous quantitative growth simply does not exists, cannot be sustained. Humanity is not some kind of a different, independent species, separate from the natural system, we cannot invent our own laws, artificial bubbles within the natural system, at the end of the day we are not "creators", we can be "wise researchers, scientists" examining, studying the system we exist in and work out the best way of adapting to it.
    By now our "childhood" with the reckless experimentation, ignorance, "playing games" is over, we reached the limit of what was possible to achieve in a greedy, exploitative, excessive way, and we have already caused enough destruction along the way.
    From now on either we learn adaptation to the system or we will become extinct.
    We are not in a Hollywood movie with guaranteed happy ending, the ending depends solely on us.
    The fiscal stimulus that "worked" according to the article and what many experts still calling for is like an injection to a dead animal, makes it react, but it cannot be revived.
    2. Mutually global responsibility
    As the article describes we still try to exist in a self-centred, egoistic way, only making calculations for ourselves, totally ignoring the rest of the system.
    And we cannot continue existing such a way in a system that has become globally interconnected and interdependent. If our priority is not primarily the safeguard of the global system then we all lose.
    When everybody is sitting on the same sinking boat, each and every person or nation who does not give 100% of their ability in order to keep the boat floating and sailing in the right direction is the same as if he/she stole from the boat, or drilled a hole on the wall of the boat.
    These are not philosophies, "recommendations", these are laws of the global, integral, natural system we evolved into.
    Not knowing, not keeping, ignoring the natural laws does not excuse and save one from the dire consequences.

  7. CommentedRalph Musgrave

    The idea that “excess savings chronically dampen demand” is old as the stars. That’s nothing more than Keynes so called “paradox of thrift”. In other words if the private sector is determined to have a bigger stock of very liquid savings (i.e. money or near money) the government just has to print money and issue it, else we get excessive unemployment. It’s all desperately simple.