Blog Post

The persistence of slow growth

What’s at stake: The persistence of slow economic growth in the Great Recession has been puzzling. Two recent papers have tried to present a coherent framework for understanding this phenomenon. The first paper argues that we may have underestimated the importance of hysterisis effects. The second paper argues the global safe asset shortage cannot be resolved by lower world interest rates once we reach the zero lower bound. It is instead dissipated by a world recession that rebalances global asset markets.

By: Date: November 16, 2015 Topic: Global Economics & Governance

Story one: Hysterisis and Superhysterisis

Olivier Blanchard, Eugenio Cerutti and Lawrence Summers write that a surprisingly high proportion of recessions, about two-thirds, are followed by lower output relative to the prerecession trend even after the economy has recovered. Perhaps even more surprisingly, in about one-half of those cases, the recession is followed not just by lower output, but by lower output growth relative to the prerecession output trend. That is, as time passes following recessions, the gap between output and projected output on the basis of the prerecession trend increases. If these correlations are causal, they suggest important hysteresis effects and even “superhysteresis” effects (the term used by Laurence Ball (2014) for the impact of a recession on the growth rate rather than just the level of output).

Olivier Blanchard, Eugenio Cerutti and Lawrence Summers write that the evolution of Portugal is representative of the evolutions of a number of European countries. All but one of the recessions since 1960 appear to be associated not only with a lower level of output relative to trend, but even with a subsequent decrease in trend growth, and thus increasing gaps between actual output and past trend.

BEBR 13 11 2015

Olivier Blanchard, Eugenio Cerutti and Lawrence Summers write that it is difficult to think of mechanisms through which the recession leads to lower output growth later, i.e. to “superhysteresis”. Permanently lower output growth requires permanently lower total factor productivity growth; the recession would have to lead to changes in behavior or in institutions, which lead to permanently lower research and development or to permanently lower reallocation. These may range from increased legal or self-imposed restrictions on risk-taking by financial institutions, to changes in taxation discouraging entrepreneurship. While these mechanisms may sometimes be at work, the proportion of cases where the output gap is increasing seems too high for this to be a general explanation.

Story 2: The global safe asset shortage at the ZLB

Ricardo Caballero, Emmanuel Farhi, Pierre-Olivier Gourinchas wrote in previous research that global imbalances were primarily the result of the great diversity in the ability to produce safe stores of value around the world, and of the mismatch between this ability and the local demands for these assets. In particular, the authors highlighted the US as the main producer of (safe) assets, and China, oil-producing economies and Japan as the main sources of demand for these stores of value. The growing global shortage of safe assets imparted a strong downward secular trend to world real (safe) interest rates for more than two decades. Capital flows acted as the propagating mechanism by which the asset-scarce regions dragged asset-rich regions’ interest rates down.

In a new research paper, Ricardo Caballero, Emmanuel Farhi, Pierre-Olivier Gourinchas write that with unprecedented low natural interest rates across the world following the Great Recession the equilibrating mechanism they highlighted in previous work has little space to operate. Once real interest rates cannot play their equilibrium role any longer, global output becomes the active margin: lower global output – by reducing income and therefore asset demand more than asset supply – rebalances global asset markets. In this world, liquidity traps emerge naturally and countries drag each other into them.

Ricardo Caballero, Emmanuel Farhi, Pierre-Olivier Gourinchas write that countries with large safe asset shortages run current account surpluses and drag the world interest rate down. Once at the ZLB, the global asset market is in disequilibrium: there is a global safe asset shortage that cannot be resolved by lower world interest rates. It is instead dissipated by a world recession, which reduces income and therefore asset demand more than asset supply. In this environment, surplus countries push world output down, exerting a negative externality on the world economy.

Paul Krugman writes that international capital mobility makes a liquidity trap in just one country less likely, but it by no means rules that possibility out. The equalization of Japanese real rates with those of the rest of the world didn’t, for example, occur through an equalization of Wicksellian natural rates following a depreciation of the currency. Instead, what happened was that persistent deflation in Japan, combined with the zero lower bound, kept the actual real interest rate well above the Wicksellian rate.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

The US retail crisis

What’s at stake: America is undergoing a retail sector crisis, partly related to the increase of competition from online commerce. We review recent contributions to this debate.

By: Silvia Merler Topic: Innovation & Competition Policy Date: July 17, 2017
Read article More by this author

Blog Post

The Universal Basic Income discussion

What’s at stake: the concept of a Universal Basic Income (UBI), an unconditional transfer paid to each individual, was prominent earlier this year when Finland announced a pilot project. It’s now back in the discussion as the OECD published a report illustrating costs and distributional implications for selected countries. We review the most recent contributions on this topic.

By: Silvia Merler Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 12, 2017
Read about event More on this topic

Past Event

Past Event

CANCELLED - What should be Greece's next growth model?

Due to unforeseen circumstances, we will have to cancel this event.

Speakers: Kuriakos Mitsotakis and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 8, 2017
Read article More on this topic More by this author

Blog Post

President Trump’s budget: the 3% growth quandary

What’s at stake: the Trump administration released its full budget proposal. Economists have been arguing about the feasibility of the underlying growth assumptions, and on whether there is a double-counting implied. We review the most recent contributions to this debate.

By: Silvia Merler Topic: Global Economics & Governance Date: May 29, 2017
Read article More on this topic More by this author

Blog Post

Dial N for NAIRU, or not?

What’s at stake: The concept of the NAIRU (Non-Accelerating Inflation Rate of Unemployment) has recently divided the minds in the economic blogosphere. We review the most important contributions on its usefulness, its shortcomings, alternatives and we discuss why it is such a contested concept.

By: Pia Hüttl Topic: Global Economics & Governance Date: May 22, 2017
Read article More on this topic

Blog Post

UK economic performance post-Brexit

What’s at stake: Almost a year after the UK voted to leave the European Union, its economic performance has showed mixed results. The risks of a Brexit-induced recession do not seem to be materialising. On the contrary, up until the end of 2016 the UK saw a continuation of strong consumer spending and strong output in consumer-focused activities. However, the UK economy is showing signs of slowing down in the first quarter of 2017, with weak growth in the services sector and business investments. In addition, strong consumption growth started to cool down as individuals’ purchasing power declines due to a weaker exchange rate. This leads to a question whether it is the beginning of the Brexit slowdown. We review the contributions made on this topic in the last year.

By: Uuriintuya Batsaikhan and Justine Feliu Topic: European Macroeconomics & Governance Date: May 15, 2017
Read article More on this topic More by this author

Blog Post

The US and the productivity puzzle

What’s at stake: Productivity growth fell sharply following the global financial crisis and has remained sluggish since, inducing many to talk of a “productivity puzzle”. In the US, we may be seeing what look like early signs of a reversal. We review recent contributions on this theme.

By: Silvia Merler Topic: Global Economics & Governance Date: May 8, 2017
Read article More on this topic

Blog Post

Europeans rediscover enthusiasm for globalisation

The general political mood on both sides of the Atlantic seems to suggest declining public support for globalisation, but people in the EU increasingly see globalisation as an opportunity for economic growth. This shift in public opinion coincides with improved economic conditions.

By: Uuriintuya Batsaikhan and Zsolt Darvas Topic: European Macroeconomics & Governance Date: May 4, 2017
Read article More on this topic More by this author

Blog Post

The Trump tax cut

What’s at stake: on Wednesday, the Trump administration - now 100 days old - unveiled a draft tax plan including the intention to enact a radical cut to the corporate income tax, lowering it to 15 percent. While we are still missing details on how this and other measures would be implemented, we review some of the early reactions.

By: Silvia Merler Topic: Global Economics & Governance Date: May 2, 2017
Read article More on this topic More by this author

Blog Post

The decline of the labour share of income

What’s at stake: at odds with the conventional wisdom of constant factor shares, the portion of national income accruing to labour has been trending downward in the last three decades. This phenomenon has been linked to globalisation as well as to the change in the technological landscape - particularly “robotisation”. We review the recent literature on this issue.

By: Silvia Merler Topic: Global Economics & Governance Date: April 24, 2017
Read article More on this topic More by this author

Blog Post

Building a more resilient and inclusive global economy

Curtain raiser speech ahead of the 2017 IMF Spring Meetings delivered at Bruegel by the Managing Director of the International Monetary Fund.

By: Christine Lagarde Topic: Global Economics & Governance Date: April 12, 2017
Read article Download PDF More on this topic

Working Paper

From start-up to scale-up: examining public policies for the financing of high-growth ventures

What are the challenges of financing scale-ups, and how can long-term public policies support the creation of a better scale-up environment?

By: Gilles Duruflé, Thomas Hellmann and Karen E. Wilson Topic: Innovation & Competition Policy Date: April 10, 2017
Load more posts