Economics Baby boomers turbo charged the post-war recovery. But the ageing boomers are part of a new stagnation that even zero rates can't fix.
In 1938 the US economist Alvin Hansen, sometimes referred to as "the American Keynes", warned his country faced a bleak future that would be characterised by low growth and high unemployment.
He coined the expression "secular stagnation" to describe the outlook.
His pessimism was driven by his belief that falling demand due to the depression-related falling birth rate would reduce investment. He saw the end of the expansion of America's farmlands.
He was wrong.
Thanks in no small part to World War II Hansen's secular stagnation failed to eventuate.
The war created a quantum leap in the demand for defence-related output. The war was funded to a significant degree by the patriotic enthusiasm for Liberty bonds.
Employment opportunities for women, especially in the defence-related manufacturing sector, were opened up in a fashion not seen before. The post-war baby boom turbocharged a US economy that played economic catch-up for those years it had run a warbased economy. When the war ended, the US led the advanced economies on an economic march of growth that lasted until the early 1970s.
Now, we once more see geopolitical forces coming into play around the globe in such a way that wars of some sort appear inevitable. Do not expect these wars to have the economic silver lining that America enjoyed in the 1940s.
Once again we have another Harvard professor, this time Lawrence Summers, warning his country of the
risks – low growth, low rates and low inflation – it faces from secular stagnation.
The new case argues that advanced economies are suffering from inadequate demand and have been for some time. To achieve full employment, economic performance has required ever-lower interest rate levels.
These have spurred bursts of growth by the inflating of asset bubbles.
We saw, even before the crisis in the US, that the creation of a huge housing bubble had not been enough to lift the economy back to full employment. This condition of chronic demand deficiency has been exacerbated by the global financial crisis. Despite fiveyears of recovery, the US economy has continued to operate well below potential.
Says Summers: "The new secular stagnation hypothesis suggests that macro-economic policy as currently structured and operated, may have difficulty maintaining a posture of full employment and production at potential, and that if these goals are attained there is likely to be a price paid in terms of financial stability."
Low interest rates and low inflation are at the core of the problem. Official or nominal interest rates are at record lows but they can only fall to the zero-bound, which means they cannot fall below zero. Real rates can go below zero. Consider an official nominal rate of 2 per cent with inflation running at 3 per cent. The nominal rate is in positive territory even though the real rate is below zero.
Theoretically at least, there is a level at which the animal spirits of entrepreneurs will be aroused and they will borrow at the ultra-low negative real rates and begin investing and hiring. But, as Summers points out above, this figure could well be incompatible with financial stability.
While the numbers involved in the illustration are not actual examples, they are close to real life.