Sep 4th 2017

The Normalization Delusion

by Adair Turner

 

Adair Turner, Chairman of the Institute for New Economic Thinking and former Chairman of the UK Financial Services Authority, is Chair of the Energy Transitions Commission. 



LONDON – There is a psychological bias to believe that exceptional events eventually give way to a return to “normal times.” Many economic commentators now focus on prospects for “exit” from nearly a decade of ultra-loose monetary policy, with central banks reducing their balance sheets to “normal” levels and gradually raising interest rates. But we are far from a return to pre-crisis normality.

After years of falling global growth forecasts, 2017 has witnessed a significant uptick, and there is a good case for slight interest-rate increases. But the advanced economies still face too-low inflation and only moderate growth, and recovery will continue to rely on fiscal stimulus, underpinned if necessary by debt monetization.

Since 2007, per capita GDP in the eurozone, Japan, and the United States are up just 0.3%, 4.4%, and 5%, respectively. Part of the slowdown from pre-crisis norms of 1.5-2% annual growth may reflect supply-side factors; productivity growth may face structural headwinds.

But part of the problem is deficient nominal demand. Despite central banks’ massive stimulus efforts, nominal GDP from 2007-16 grew 2.8% per year in the US, 1.5% in the eurozone, and just 0.2% in Japan, making it impossible to achieve moderate growth plus annual inflation in line with 2% targets. US inflation has now undershot the Federal Reserve’s target for five years, and has trended down over the last five months.

Faced with this abnormality, some economists search for one-off factors, such as “free” minutes for US cell phones, that are temporarily depressing US inflation measures. But mobile-phone pricing in the US cannot explain why Japan’s core inflation is stuck around zero. Common long-term factors must explain this global phenomenon.

Labor-market developments are key, with wage growth remaining stubbornly low even as unemployment falls to “normal” pre-crisis levels. Japan is the most extreme case: with a shrinking labor force, minimal immigration, and a 2.8% unemployment rate, all standard models predict accelerating wage growth. But however much Prime Minister Shinzo Abe urges employers to give Japanese workers a raise, growth in compensation remains sluggish: in June, total wages grew just 0.4%. In the US, too, each new batch of monthly data indicates strong employment growth and surprisingly low wage growth.

Three factors may explain this trend. For 30 years, labor markets have become more flexible, with trade union power dramatically weakened. At the same time, globalization has exposed workers in the tradable sector to global wage competition. But, most important, information technology delivers ever-expanding opportunities to automate all economic activities. In a fully flexible market labor with, as it were, a reserve army of robots, the potential for pervasive automation can depress real wage growth even with full employment.

Nominal demand, meanwhile, is still being held back by an overhang of unresolved debt. Between 1950 and 2007, advanced economies’ private debt grew from 50% to 170% of GDP. Since 2008, debt has shifted from private to public sectors, with large fiscal deficits both an inevitable consequence of post-crisis recession and essential to maintain adequate demand. In addition, the global economy has been kept going by China’s enormous leverage increase, with the debt-to-GDP ratio up from around 140% in 2008 to 250% today. Worldwide, total public and private debt has reached a record high, up from 180% of global GDP in 2007 to 220% in March 2017. As a result, interest rates cannot return to pre-crisis levels without risking a new recession.

Facing this debt overhang, loose monetary policy alone was bound to be ineffective and, beyond some point, potentially harmful and counterproductive. Neither investment nor consumption responds strongly to ever-lower interest rates when debt burdens are high. Very low interest rates, meanwhile, generate asset-price increases, which benefit the already wealthy and reduce the income of less wealthy bank depositors, who in some circumstances might cut consumption more than deeply indebted borrowers increase it.

In this context, as Princeton University economist Christopher Sims argued in 2016, loose monetary policy cannot work through normal transmission channels, and is effective if, and only if, it facilitates fiscal expansion by keeping government borrowing costs low. Nominal GDP in the US has grown faster than in the eurozone since 2007, because the US ran deficits averaging 7.2% of GDP versus the eurozone’s 3.5%. Global growth today is crucially underpinned by China’s 3.7%-of-GDP fiscal deficit, up from 0.9% in 2014. Japan’s continued growth is assured only by large fiscal deficits stretching well into the 2020s; the Bank of Japan, which now holds government bonds equivalent to about 75% of GDP, will hold some of them forever, permanently monetizing accumulated fiscal debts.

The partial recovery this year thus reflects neither a return to pre-crisis normality nor the success of monetary policy alone. But, even if inflation rates remain below target, there is still a good case for some interest-rate increases. Because ever-looser monetary policy alone is decreasingly effective beyond some point, it can be partly reversed with little danger to nominal demand; and slightly higher interest rates would temper, even if only mildly, the inegalitarian impact of the current policy mix.

But the rate increases will and should be very small. I doubt that the US federal funds rate will exceed 2.5% in 2020, while Japanese and eurozone rates will rise only marginally, probably remaining well below 1%. Inflation is more likely to undershoot than to exceed 2% targets. Moderate growth at best will be insufficient to offset the impact of the lost decade of 2007-17.

The psychological bias to expect a return to “normality” will remain strong. But the drivers of post-crisis economic performance are so deep that no return to normality is likely any time soon.


Adair Turner is Chairman of the Institute for New Economic Thinking and former Chairman of the UK Financial Services Authority. The paperback edition of his book Between Debt and the Devil has now been published, with a new Afterword assessing the latest economic developments and their political consequences.

Copyright: Project Syndicate, 2017.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Sep 21st 2019
EXTRACT: "As Lobaczewski pointed out, pathological leaders tend to attract other people with psychological disorders. At the same time, empathetic and fair-minded people gradually fall away. They are either ostracised or step aside voluntarily, appalled by the growing pathology around them.......As a result, over time pathocracies become more entrenched and extreme. You can see this process in the Nazi takeover of the German government in the 1930s, when Germany moved from democracy to pathocracy in less than two years.......In the US, there has clearly been a movement towards pathocracy under Trump. As Lobaczewski’s theory predicts, the old guard of more moderate White House officials – the “adults in the room” – has fallen away. The president is now surrounded by individuals who share his authoritarian tendencies and lack of empathy and morality. Fortunately, to some extent, the democratic institutions of the US have managed to provide some push back."
Sep 16th 2019
EXTRACT: "If the Supreme Court does agree with the Divisional Court that the question is political rather than legal, it will take the UK constitution into quite peculiar territory. Prime ministers will be the new kings and queens. They will be free to suspend parliament at will, and for as long as they wish, without any judicial interference. Parliament will meet not out of constitutional necessity but in the service of the government’s interests – namely, to pass its legislation and to maintain appearances, rather than to hold it to account."
Sep 12th 2019
Extract: "The Republican Party has lashed its fate to an increasingly unhinged leader. Though three other presidential hopefuls for 2020 now stand in Trump’s way, none can defeat him. But they can damage his reelection effort, which is why the Republican Party has been scrapping some primaries and caucuses. How well Trump does in November next year may well depend on how his fragile ego withstands the coming months."
Sep 2nd 2019
EXTRACTS: "Most people think of revolutions as sudden earthquakes or volcanic eruptions that come without warning and sweep away an entire political system. But historians, political scientists, and even the odd politician know that the reality is very different: revolutions happen when systems hollow themselves out, or simply rot from within. Revolutionaries can then brush aside established norms of behavior, or even of truth, as trivialities that should not impede the popular will............ Only time will tell whether we are currently witnessing the hollowing out of British democracy. But Prime Minister Boris Johnson may well have crossed some invisible Rubicon by.......... Whatever happens now, British parliamentary democracy may never be the same again. It will certainly never again be the model that so many people around the world once admired."
Aug 29th 2019
EXTRACT: "Events such as prorogations and dissolutions happen when countries face difficult times. Therefore, because of the disastrous effects of Brexit: sterling in freefall; a recession looming on the horizon and Britain’s international standing at its lowest ebb since Suez, it is no surprise that the country is in this position now. The worrying thing is that using the monarchical power of prorogation does not solve problems – it has a history of turning them into frightening and often violent crises. There is a worrying relationship between the use of such powers and a complete breakdown in government."
Aug 28th 2019
EXTRACT: "Reminiscent of Don Quixote, Trump is tilting at windmills. His administration is flailing at antiquated perceptions of the Old China that only compound the problems it claims to be addressing. Financial markets are starting to get a sense that something is awry. So, too, is the Federal Reserve. Meanwhile, the global economy is fraying at the edges. The US has never been an oasis in such treacherous periods. I doubt if this time is any different. 
Aug 24th 2019
EXTRACT: "In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession. The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession."
Aug 21st 2019
EXTRACT: "Climate change is real, and it is a problem. According to the IPCC, the overall impact of global warming by the 2070s will be equivalent to a 0.2-2% loss in average income. That’s not the end of the world, but the same as a single economic recession, in a world that is much better off than today.  The risk is that outsized fear will take us down the wrong path in tackling global warming. Concerned activists want the world to abandon fossil fuels as quickly as possible. But it will mean slowing the growth that has lifted billions out of poverty and transformed the planet. That has a very real cost. "
Aug 20th 2019
EXTRACTS: "It is no exaggeration to say that Johnson has lied his way to the top, first in journalism and then in politics. His ascent owes everything to the growing xenophobia and English nationalism that many Conservatives now espouse................Johnson has chosen a government of like-minded anti-European nationalists. His principal adviser, Dominic Cummings, was described by David Cameron, Britain’s prime minister from 2010 to 2016, as a “career psychopath.” Cummings is, alongside Johnson, the most powerful figure in the new government; he is an unelected wrecker who earlier this year was ruled to be in contempt of parliament. Fittingly, if depressingly, he now is masterminding our departure from the EU with or without parliamentary approval."
Aug 19th 2019
EXTRACTS: "Back in May, a jury found Patrick Syring, a former State Department official, guilty of 14 counts of making threats against my life and my staff at the Arab American Institute. This week, a federal judge sentenced Syring to five years in prison to be followed by three years of court-ordered probation.................It gives me no pleasure to see this man going to jail for a long period, but it does provide us all with a sense of enormous relief. I've been threatened before. My wife, my children, and I have received death threats for the past 50 years – owing to my advocacy for Palestinian rights and the rights of the Arab American community. My office was fire-bombed and an Arab American colleague, whom I hired, was murdered. Two individuals who, in the past, made death threats against me and my children were convicted and sentenced to prison terms. But this case was different."
Aug 15th 2019
EXTRACT: "Gaslighting typically refers to intimate relationships. It’s a way of controlling someone by creating false narratives – for example, that they are irrational or crazy. If such lies are repeated constantly, victims may get confused and start believing there really is something wrong with them. Confusion, diversion, distraction and disinformation can similarly be used to gaslight an entire society. So how can you tell if you are being gaslighted, and how do you avoid it in the first place?"
Aug 14th 2019
EXTRACT: "Trump has once again painted himself into a corner. Since the latest massacres, he’s been at pains to present himself as a reasonable fellow who can get behind gun reform (and perhaps mollify suburban women, his most dangerous foes on this issue). But he’s also noticeably (and typically) anxious to maintain the loyalty of the rural voters who form an important part of his base. Trump has also taken the gamble of using racial politics and white supremacy as instruments for winning in 2020. When faced with the dilemma of trying to assuage suburban voters or keeping the base close, time after time his instinct has been to shore up the base. (That didn’t work very well in 2018.)"
Aug 5th 2019
Extracts: "it is impossible to model many of the most important risks. Global warming will produce major changes in hydrological cycles, with both more extreme rainfall and longer more severe droughts. This will have severe adverse effects on agriculture and livelihoods in specific locations, but climate models cannot tell us in advance precisely where regional effects will be most severe. Adverse initial effects in turn could produce self-reinforcing political instability and large-scale attempted migration........Achieving a zero-carbon economy will require a massive increase in global electricity use, from today’s 23,000 TW hours to as much as 90,000 TW hours by mid-century. Delivering this in a zero-carbon fashion will require enormous investments, but as the Energy Transitions Commission has shown, it is technically, physically, and economically feasible......Added up across all economic sectors, however, it’s clear that the total cost of decarbonizing the global economy cannot possibly exceed 1-2% of world GDP. In fact, the actual costs will almost certainly be far lower, because most such estimates cautiously ignore the possibility of fundamental technological breakthroughs, and maintain conservative estimates of how long and how fast cost reductions in key technologies will occur. In 2010, the International Energy Agency projected a 70% fall in solar photovoltaic equipment costs by 2030. It happened by 2017."
Jul 31st 2019
Extract: "I admire the US for its culture, entrepreneurialism, and universities, and I have many American friends. Furthermore, I know how grateful the rest of the world has to be for US leadership after World War II. Never before had a victorious power behaved so generously toward others, including the defeated. We owe so much to US policy in the second half of the twentieth century. But although I am no declinist regarding American economic, intellectual, and military power, the country’s soft power has certainly decreased, and its positive influence around the world has declined. The reason for this is simple: US President Donald Trump is a bad man surrounded by a bad team of incompetent and dangerous ideologues."
Jul 30th 2019
Extract: "This pattern holds true in every extremist movement I have studied, whether from the past or the present, or the West or the East. This abuse of religion that provides security and certainty to those who are experiencing a loss of control is a universal phenomenon. If merely left there, it would not be a danger. But when it masks a political agenda or when it justifies violence either by groups or state actors, it becomes a danger."
Jul 30th 2019
Extract: "......the day before Mueller testified, the current FBI director, Christopher Wray, told the Senate Judiciary Committee, “The Russians are absolutely intent on trying to interfere with our elections.” And the day after Mueller testified, the Senate Intelligence Committee issued a report stating that Russia would be involved in the next presidential election, and that countries like Saudi Arabia, Iran, and China have the capacity to interfere in US elections as well. Despite these warnings, Senate Majority Leader Mitch McConnell blocked Senate consideration of two bills aimed at strengthening US election security,....."
Jul 15th 2019
".....one of the most accurate recession indicators, known as the yield curve, has recently been flashing warning signs. Every postwar recession in the US was preceded by an inversion of the yield curve, meaning that long-term interest rates had fallen below short-term interest rates, some 12 to 18 months before the outset of the economic downturn."
Jul 6th 2019
Extract: ".........growing poverty even when working, the collapse of stable and safe social identities linked to work, the increasing instability of employment security, and the rapid change of local communities due to emigration, migration, collapsing housing affordability, and redevelopment initiatives that displace communities. These provide precise and urgent electoral rallying points. They are particularly effective given that so many mainstream politicians ignore these basic grievances. In recent years, the lineup of politicians opposing the New Right – Hillary Clinton, the Remain campaign, Emmanuel Macron and Matteo Renzi – have been unwilling to even recognise these structural problems. This provided the New Right the opportunity to appear credible, simply by acknowledging them."
Jul 6th 2019
".........an openly Russophilic administration in the US may be one reason why Putin’s domestic support has been declining so sharply."
Jul 3rd 2019
"Extract: .........in a world of rapidly expanding automation potential, demographic shrinkage is largely a boon, not a threat. Our expanding ability to automate human work across all sectors – agriculture, industry, and services – makes an ever-growing workforce increasingly irrelevant to improvements in human welfare. Conversely, automation makes it impossible to achieve full employment in countries still facing rapid population growth........The greatest demographic challenges therefore lie not in countries facing population stabilization and then gradual decline, but in Africa, which still faces rapid population growth."