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Is America destined for slow growth?


If you ask an American how the economy is doing, chances are she’ll tell you, “not so hot.”

Despite the fact that economic growth has been accelerating and the unemployment rate has been falling, much of the country simply feels that the U.S. economy is on the wrong track. There are many reasons for this, but likely no greater reason than the simple fact that most of us haven’t seen a raise in a long, long time.

But it’s not just that folks’ personal situations aren’t improving. Compared to previous recoveries, economic performance today has been anemic, as shown by the chart below from the Center for American Progress.


This discrepancy was perhaps the single most debated issue during the 2012 presidential campaign, as critics of President Obama blasted him for presiding over the worst economic recovery in more than half a century. The President countered that the economy’s poor performance was attributable to the fact that we had just suffered through a financial crisis of epic proportions, and that economies tend to perform worse following financial crises.

Academic studies have shown that this is the case, and if President Obama’s reelection is any indication, the American public bought the story. But a small but growing number of economists are putting forward the idea that our economic history is wrong. It is commonly supposed that the past 15 years has been dominated by two recessions–2001 and 2008/2009–with average, or even pretty good, performance in between.

But what if that narrative is just an illusion? What if we’ve really been suffering from a 15-year malaise brought on by more powerful forces that even those that caused the financial crisis? That’s the basic premise of a new theory called “secular stagnation” that’s been argued by economists of no lesser stature than former Treasury Secretary Larry Summers. In a new ebook published Friday by the Centre for Economic Policy Research on the concept, Summers and fellow economic luminaries like Paul Krugman, Barry Eichengreen, and Richard Koo explore the idea that the economy moved into an era of slower growth long ago. This was brought on by an aging wealthy world, slowing technology growth, and growing income inequality.

How has the world evolved to be less hospitable to economic growth? One reason is the fact that the wealthy world is much older today than in any time in modern economic history. Advances in medicine have allowed people, especially in the developed world, to live longer. This has lead for a much greater need to save rather than spend, as older folks tend to live off their savings than income. The authors of the book point out, for example, that the required amount of money for saving in Germany “rose from almost two times GDP in 1970 to three and a quarter times GDP in 2010.” Similar trends are happening across the wealthy world, creating a lot of demand for safe assets like U.S. government debt and pushing down interest rates over time.

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You can see from the chart above how interest rates and inflation have moved slowly but steadily downward for several years now. The effect of this is to rob central banks of the ability to stimulate the economy because naturally low interest rates prevent the ability to lower interest rates as low as necessary to jolt economies out of recessions, a dynamic that’s been clearly on display during this recovery. This excess of saving can also encourage the sort of financial bubbles we saw in 2001 and 2008 because investors are motivated to take excessive risks and reach for yield during periods of low interest rates.

But it’s not just the aging of the population that we have to contend with, but slowing population growth overall. The slowing of population growth means companies have less incentive to invest in the future because there is little reason to believe that there will be demand for their products, a dynamic that also feeds into lower overall interest rates. We’ve seen this dynamic on display for years now in Japan, which has battled a declining population, low interest rates and even deflation, slow growth and government deficits.

The standard prescription for this problem is to try to aim for higher but steady inflation of say 4%, rather than the 2% target of today. This would give policy makers the ability to sufficiently lower interest rates during times like today when negative real interest rates are necessary to stimulate growth. But the experience in Japan shows just how difficult it is when there are so many headwinds fighting against higher inflation, let alone a strong political opposition to any sort of inflation at all.

As for fiscal policy, it’s no sure thing that fiscal policy can jolt us out of this demographic crunch either. As Paul Krugman–no skeptic of the salutory power of federal spending–writes in his section:

What about fiscal policy? Here the standard argument is that deficit spending can serve as a bridge across a temporary problem, supporting demand while, for example, households pay down debt and restore the health of their balance sheets, at which point they begin spending normally again. Once that has happened, monetary policy can take over the job of sustaining demand while the government goes about restoring its own balance sheet. But what if a negative real natural rate isn’t a temporary phenomenon? Is there a fiscally sustainable way to keep supporting demand?

In other words, we could take advantage of low interest rates and use deficit spending to prop up demand, but what’s the end game in that scenario? The case of Japan has showed that government spending can support the economy and living standards for years without debt markets revolting, but nobody is sure how that country will begin to reduce its debt and shift the burden of economic growth back to the private sector.

Looking deeply into their crystal balls, some of the brightest minds in economics see the U.S. and much of the developed world turning Japanese. And that’s not a future most of us want to court.