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The Problem With Secular Stagnation

DELHI – In a recent exchange between former US Federal Reserve Chairman Ben Bernanke and former US Treasury Secretary Larry Summers on the plausibility of secular stagnation, one point of agreement was the need for a global perspective. But from that perspective, the hypothesis of secular stagnation in the period leading up to the 2008 global financial crisis is at odds with a central fact: global growth averaged more than 4% – the highest rate on record.

The same problem haunts Bernanke’s hypothesis that slow growth reflected a “global savings glut.” From a Keynesian perspective, an increase in savings cannot explain the surge in activity that the world witnessed in the early 2000s.

Supporters of the secular-stagnation hypothesis, it seems, have identified the wrong problem. From a truly secular and global perspective, the difficulty lies in explaining the pre-crisis boom. More precisely, it lies in explaining the conjunction of three major global developments: a surge in growth (not stagnation), a decline in inflation, and a reduction in real (inflation-adjusted) interest rates. Any persuasive explanation of these three developments must de-emphasize a pure aggregate-demand framework and focus on the rise of emerging markets, especially China.

Essentially, the world witnessed a large positive productivity shock emanating from the emerging markets, which accelerated world growth while reinforcing disinflationary pressures that had already been set in motion by the so-called Great Moderation in business-cycle volatility. This key development helps to reconcile two of the three major global developments: faster growth and lower inflation.