Secular stagnation: looking to a gloomy future

Marco Madzzar


August 20th, 2015

What explains the sluggish economic growth in the developed world? Marco Madzzar discusses.

It is not an overstatement to describe economic growth in much of the developed world—especially in the US and Europe—as lacklustre. Since the Global Financial Crisis of 2007–8, growth rates have consistently remained below trend. Notably, this dilemma has persisted for the last 7 years, so it’s about time we better understand why growth hasn’t returned to its pre-crisis trajectory.

A cogent explanation is provided by the ‘secular stagnation’ hypothesis—recently popularised by Larry Summers, former Director of the National Economic Council. Summers attributes slow growth to a global savings glut that is most prominent in the US and Europe. 

Natural real interest rate

At the centre of the secular stagnation hypothesis are two types of interest rates: the natural real interest rate (“natural rate”) and the actual real interest rate (“actual rate”).

The natural rate is essentially determined by the number of borrowers and savers in the economy. More borrowers will lift the rate; more savers will lower the rate.

The actual rate, on the other hand, is the interest rate set by the central bank, minus inflation. For example, a 2% interest rate and 1% inflation rate will result in a 1% actual rate.

Particular economists, such as Paul Krugman, believe that GDP will expand at its historical rate of 3–4% only if the actual rate equals the natural rate. Whereas the actual rate in the US is positive,[1] excessive saving, which is at the heart of the stagnation hypothesis, has pulled down the natural rate to around negative 2%.

We therefore find ourselves trapped in a trajectory of deficient economic growth. Until these two rates match, we cannot expect higher growth. As central banks cannot set a negative interest rate, and inflation is stubbornly low, the only solution is a rise in the natural rate.

Savings glut


Larry Summers

In order for the natural rate to rise, borrowing must rise. However, the sum of savings has been increasing in the global economy since the late 1990s.

A popular explanation for rising savings is a change in demographics. As populations age in most parts of the developed world, more workers are approaching the end of their careers. These workers are generally net savers as they have already incurred the major expenses in life: buying the family home, child rearing, putting kids through school, etc. As more people exit the labour force, the savings rate invariably rises.

The other commonly argued contributor is rising income inequality. This was put forward by Larry Summers, who believes that higher income earners generally have a higher propensity to save than their less fortunate counterparts. As a greater share of income is concentrated in the hands of fewer people, aggregate consumption begins to fall, whilst savings rise.

This argument is quite intuitive. There is little sense in the rich spending every $1 increase in their income only to stockpile more houses, cars, boats and all the other toys they enjoy. Those living on the minimum wage, however, are most likely to spend an increase in their income on basic necessities, such as food and accommodation.

Looking to the future

An obvious solution to the dilemma posited by secular stagnation would be to spend more. Governments could intervene by soaking up the excessive savings in the global economy and spend it on infrastructure or social security. However, more sovereign debt would be politically unpalatable in the US and Europe, where stagnation is most acute.

Another solution may involve a redistribution of income from the rich to the poor. This would increase spending by putting more money in the hands of those who will spend it. The drawback is that this solution requires higher progressive taxes which is also likely to face political opposition.

According to Ben Bernanke, former Chairman of the Federal Reserve, the solution is unfettered global trade. He argues that money should simply move from the developed world, currently in the midst of a savings glut, to other parts of the world with a shortage of savings. The falling currencies that follow in the developed world would generate an export-fuelled recovery.

However, Bernanke’s argument neglects an important observation. The excess savings in Europe and the US are largely stored in low-risk investments such as German and US Government bonds. This suggests investors are hesitant to move their savings to parts of the world that are riskier yet offer greater yields.

Government policies should focus, then, on making places such as Africa and Asia more attractive to investors. This would partly involve tackling corruption and improving opportunities for foreign direct investment in high-yielding infrastructure programs that exist in those parts of the world. Despite being a massive obstacle, higher growth in Africa and Asia would surely benefit other nations grappling with secular stagnation.



[1] Despite central banks setting interest rates of 0–1% in many developed countries, inflation in those countries is very low and results in a positive actual rate.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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