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 by this author

Blog Post

It’s hard to live in the city: Berlin’s rent freeze and the economics of rent control

A proposal in Berlin to ban increases in rent for the next five years sparked intense debate in Germany. Similar policies to the Mietendeckel are currently being discussed in London and NYC. All three proposals reflect and raise similar concerns – the increase in per-capita incomes is not keeping pace with increases in rents, but will a cap do more harm than good? We review recent views on the matter.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: July 8, 2019
Read article More on this topic More by this author

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou Topic: Finance & Financial Regulation Date: July 1, 2019
Read article More on this topic More by this author

Blog Post

The June Eurogroup meeting: Reflections on BICC

The Eurogroup met on June 13th to discuss the deepening of the economic and monetary union (EMU) and prepare the discussions for the Euro Summit. From the meeting came two main deliverables: an agreement over a budgetary instrument for competitiveness and convergence and the reform of the European Stability Mechanism (ESM) treaty texts. We review economists’ first impressions.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: June 24, 2019
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: Making a success of EU cohesion policy

Bruegel senior fellow Zsolt Darvas talks to Sean Gibson in this Deep Focus podcast about how the EU can improve its cohesion policy, citing the best examples of its implementation and stressing the methodological difficulties in measuring its effectiveness.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 20, 2019
Read article More on this topic More by this author

Blog Post

The campaign against ‘nonsense’ output gaps

A campaign against “nonsense” consensus output gaps has been launched on social media. It has triggered responses focusing on the implications of output gaps for fiscal policy under EU rules, especially for Italy. But the debate about the reliability of output-gap estimates is more wide-ranging.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: June 17, 2019
Read article Download PDF More on this topic

External Publication

Effectiveness of cohesion policy: learning from the project characteristics that produce the best results

This study by Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza, and Catarina Midões analyses the characteristics of cohesion policy projects that can contribute to successful outcomes. Their analysis is based on a literature survey, an econometric analysis and interviews with stakeholders. About two dozen project characteristics are considered, and their association with economic growth is studied using a novel methodology. Based on the findings, the study concludes with recommendations for cohesion policy reform.

By: Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: June 11, 2019
Read article More on this topic More by this author

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: June 11, 2019
Read article More on this topic

Blog Post

A European atlas of economic success and failure

Economic growth was diverse across EU regions, yet it is crucial to control for region-specific factors in assessing growth performance. We find that there are rather successful regions in many EU countries, suggesting that the EU can provide a good framework for growth. Yet the worst performers are more concentrated in some countries, suggesting that country-specific factors can play a major role in regional development.

By: Zsolt Darvas, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: June 3, 2019
Read article More on this topic More by this author

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: June 3, 2019
Read article More on this topic More by this author

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 27, 2019
Read article Download PDF More on this topic

Policy Contribution

How to improve European Union cohesion policy for the next decade

This policy contribution investigates the performance of the design, implementation and effectiveness of cohesion policy, the most evaluated EU tool for promoting economic convergence. By analysing the effects of cohesion policy on economic growth through reviewing literature, conducting empirical research by comparing regions, as well as considering attitudes and expectations collected through interviewing stakeholders, the authors provide reform recommendations.

By: Zsolt Darvas, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: May 23, 2019
Read article More on this topic More by this author

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 20, 2019
Load more posts