New IMF managing director Kristalina Georgieva’s first speech makes bracing reading for the global financial community as it gathers this coming week in Washington for the annual IMF and World Bank meetings. Ms Georgieva noted that while two years ago growth was accelerating in 75 per cent of the world, the IMF now expects it to decelerate in nearly 90 per cent of the global economy in 2019 to the lowest level in a decade.
This shift into reverse comes as central banks in Europe and Japan have embraced negative interest rates and investors expect further rate cuts from the US Federal Reserve. Bonds worth more than $15tn are trading with negative yields.
If the primary problem were on the supply side, one would expect to see upward price pressure. Instead, despite loose fiscal and monetary policy, central banks in the industrialised world have as a group fallen well short of their inflation targets for a decade and markets project that this will continue.
Europe and Japan are engaged in black hole monetary policy. Without a major discontinuity, there is no prospect of policy rates returning to positive territory. The US appears to be one recession away from entering the same black hole. If so, the whole industrialised world would be providing at best negligible and often negative returns to risk-free savings and falling short of growth and inflation targets. It would also have to maintain financial stability amid increased incentives for leverage and risk-taking.
All this requires new thinking and new policies, much as the rapid inflation of the 1970s forced a reset back then. Once economies are in the monetary black hole, central banks that focus on inflation targeting will be ineffectual in hitting their immediate goal and unable to stabilise output and employment. The policy action has to shift elsewhere.
Today’s core macroeconomic problem is profoundly different from the problem any living policymaker has seen before. As I have been arguing for some years now, it is a version of the secular stagnation — chronic lack of demand — that terrified Alvin Hansen during the Depression. In today’s global economy, private investment demand is manifestly unable to absorb private savings even with negative real interest rates and limited restraints on financial markets. That is why even with burgeoning government debt and unsustainable lending, growth remains sluggish and below target.
Since 2013, when I first argued that we were seeing more than simple “economic headwinds”, interest rates have been much lower, fiscal deficits have been much larger, and leverage and asset prices have been much higher than expected. Yet growth and inflation have fallen short of forecasts. That is exactly what one would expect from secular stagnation: a chronic shortage of private sector demand.
What is to be done? To start it would be helpful if policymakers acknowledged this week that the policy problem is not smoothing cyclical fluctuations or preventing profligacy. Rather the fundamental issue is assuring that global demand is sufficient and reasonably distributed across countries.
The place to start is by dampening down trade wars — deeds, threats and rhetoric. Trade warriors think they are participating in zero-sum games globally with one country gaining demand at the expense of another by opening markets or imposing protection. In fact trade conflicts are negative-sum games because there is no winner to offset the demand that is lost when uncertainty inhibits and delays spending decisions.
Given the risk of a catastrophic deflationary spiral, central banks are probably right to attempt to ease monetary conditions. But diminishing returns have surely set in with respect to monetary policy and there is risk of doing real damage to the health of the banks and other financial intermediaries.
Most important governments need to rethink fiscal policy. Government debt or government support for private debt is needed to absorb savings flows. With real rates near zero or even negative, the cost of debt service is very low and low rates can be locked in for decades. That means that the debt levels that were prudent when rates were at 5 per cent no longer apply in today’s zero interest rate world. Governments that run chronic surpluses are failing to do their part to support the global economy and should be the object of international scrutiny.
There are other possible interventions. Increasing pay-as-you-go public pensions would reduce private saving without pushing up deficits. Public guarantees could spur private green investments. New regulations that prompt businesses to accelerate their replacement cycles will increase private investment. Measures to create more hospitable environments for investment in developing countries can also promote the absorption of global saving.
Spurring sound spending is the antidote to secular stagnation and monetary black holes. It should be an easier technical problem to solve and much easier to sell politically than the austerity challenges of earlier eras. But problems cannot be solved until they are properly diagnosed and the global financial community is not there yet. Hopefully that will change this week.
The writer, a former US Treasury secretary, is a Harvard economics professor. The article draws on collaborative work with Anna Stansbury, PhD candidate at Harvard