Commentary Type

Slow Growth Is a Fact of Life in the Post-Crisis World

Published in the Financial Times


Once the acute phases of the financial and euro crises were over, it was clear that it would take time for advanced economies to recover. The history of past financial crises gave a clear warning that recovery would typically be long and painful.

Today, the scars are largely healed but growth is still slow. Before the crisis, any economist would have predicted that an economy with interest rates close to zero and no other major brakes on demand would see high growth rates and quickly overheat. Yet this is not what we have seen. The reason, I believe, must be found in mediocre medium term prospects, which in turn affect current demand and growth.

Estimates of long term potential growth in advanced countries have come down by 0.5 to 1 percent since 2007. Some of the decline is due to ageing, some to lower productivity growth. The effect of an ageing population was largely predictable, and indeed largely predicted. (Whether it was taken into account by firms thinking about their investment plans is unclear.)

Productivity growth has been much lower since 2007, more so in Europe where the rate has declined by over 1 percent in major countries, than in the United States, where it has only declined by 0.5 percent. This decline reflects in part cyclical factors and the effect of lower capital accumulation. But there is more to it: For the United States at least, the evidence points to a slowdown in underlying productivity, starting before the crisis and reflecting the end of a period of successful implementations of IT innovations. The safe assumption is that the high precrisis productivity growth rate was unusual, and we should expect lower underlying productivity growth in future.

Low potential growth is bad news for the medium term. But it may explain what is happening today. A main finding of a paper that Eugenio Cerutti, Lawrence Summers, and I wrote in 2015 was that, over the past 40 years, recessions in advanced countries have been associated surprisingly often with lower growth following the recession.

One interpretation is the presence of hysteresis, namely that the recession affects potential growth. Another is that the causality runs in reverse: Bad news about future potential growth leads to a recession. So, for example, when companies realize that sales prospects are worse than they thought, they cut down on investment. And consumers, realizing that their income prospects have worsened, cut on consumption.

Monetary policy can limit the drop, but not eliminate it. In a 2013 paper I cowrote, we showed formally that this interpretation fits postwar US data well. I believe that it also explains what we observe today. The result in this case is not a recession but a weak recovery.

This weak recovery in advanced countries also goes a long way in explaining the slowdown in emerging markets. While domestic factors play a role, and the evolution of China is largely sui generis, lower exports, less demand for commodities, and a resulting drop in commodity prices, have led to lower output.

If this new narrative is right, the baseline forecast is for a slow but continued recovery, as the adjustment to the reality of lower potential growth plays out in advanced economies, and the adjustment to the commodity bust works itself out in emerging-market and developing economies. It suggests that some of the scary talk, and some of the exotic policy measures being discussed, from helicopter money to large negative nominal rates, are not the order of the day. They should be kept in reserve in case bad things happen, but the expectation should be that they will not be needed.

The focus should be increasingly on medium term growth and the redefinition of normal fiscal and monetary policies in an environment of lower growth and lower interest rates.

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