The IMF warns us of economic stagnation & suggests fixes. We should listen.

Summary: Today’s post looks at an important new report about the IMF, another step by economists towards recognition that we’ve left the post-WWII order for a new world. Now that’s a world of persistent slow growth, in which repeated rounds of fiscal and monetary stimulus (conventional and unconventional) prevents recessions but cannot reignite strong growth. The IMF’s economists discuss possible causes and solutions.  {1st of 2 posts today.}

Contents

1. The IMF discovers secular stagnation.
2. Slowdown since the crash.
3. What comes next?
4. What should we do?
5. For More Information.

 

(1)  The IMF discovers secular stagnation

One of the great issues of our time concerns our future. Do we face continued slow growth (aka secular stagnation) or the accelerating growth of a new industrial revolution? These paths offer different challenges and require radically different central bank policies.

But central banks have been unable to prepare for either alternative because they’re stuck in the first — and often the most difficult — phase of the problem resolution process: recognition. Since the crash they’ve expected economic growth to return to normal. Year after year they’ve been disappointed, responding to a series of ad hoc improvisations that have poor grounding in economic theory and history. Yet time brings insight, and the international economic agencies have slowly come to grapple with these questions.

This post looks at the April 2015 IMF report “Where Are We Headed? Perspectives on Potential Output“.  Here’s a summary for a general audience from the IMF’s survey magazine. They open by comparing forecasts made in 2007 and 2008 with actual economic growth through 2014. Slowing, slowing, slower.

 

(2)  Slowdown of growth since the crash

It’s easy to mock the continued optimism of economists’ models, but it’s a mistake (climate skeptics make a similar mistake about climate models). These failed forecasts signal that something has changed in this century (part of the larger end of the post-WWII global regime). This report acknowledges that the situation has changed and discusses how — and possible causes.

Note that despite widespread belief that there has been no recovery, the US and world economies have grown since the crash.

Output across advanced and emerging market economies remains much lower than was expected in 2008, just before the onset of the global financial crisis, and its growth path has also been lower. Indeed, medium-term (five-year-ahead) growth expectations have been steadily revised downward since 2011 for both advanced and emerging market economies.

The repeated downward revisions to medium-term growth forecasts highlight the uncertainties surrounding prospects for the growth rate of potential output (potential growth). In advanced economies, the apparent decline in potential growth seems to have started as far back as the early 2000s and was worsened by the crisis.1 In emerging market economies, on the other hand, the decline in both potential output and its growth rate appears to have emerged only in the wake of the crisis.

(3)  What comes next?

Hope remains in the IMF for faster growth, but they acknowledge that it looks like slow growth is the best we can expect. That’s bad news for the world’s many heavily-indebted economies, for whom a long period of rapid growth offers their best hope for future prosperity.

… As economic conditions improve and activity recovers, investment growth should pick up, fostering a gradual recovery in productive capital growth in many advanced economies. However, prospects for the labor force are grimmer. … demographic factors are likely to act as a brake on growth in many advanced and emerging market economies, as populations age and workers retire.

…In sum, these scenarios suggest that potential growth in advanced economies is likely to remain below pre-crisis rates, while it is expected to decrease further in emerging market economies in the medium term. These findings imply that living standards may expand more slowly in the future. In addition, fiscal sustainability will be more difficult to maintain as the tax base will grow more slowly.

(4)  What should we do?

The IMF staff then turns to the most important part of the report: “Policy actions to raise the speed limit”. From the summary:

There is still room for optimism — the future trajectory of potential output is not set in stone. However, there is a need for action. To raise economic speed limits, policies need to encourage innovation, promote investment in productive capital, and counteract the negative impetus from aging. Although the right mix of policies will differ by country, some broad prescriptions can be made:

• Innovation can be encouraged and productivity can be enhanced with greater support for research and development — this can be achieved by strengthening patent systems and adopting well-designed tax incentives and subsidies in economies where these are low.
• Worker productivity can be increased by improving education quality and boosting secondary- and tertiary-level attainment.
• Bottlenecks that are holding back production in some emerging market economies can be eliminated through higher infrastructure spending.
• There is scope for better business conditions and improved functioning of product markets in some countries.
• Labor-force participation must be promoted, particularly among female workers in some countries, and aging workers in others — this would entail better designed tax and expenditure policies in some economies.
• Demand support through monetary and, where feasible, fiscal policy remains important in several economies to boost investment and capital growth.

This list omits the most important insight, perhaps the most important of the report: economists have little understanding about what causes growth. As a result post-WWII history gives national leaders clear advice: IMF advice is often bad for your economic health. Until the 1990s it was said you could predict outbreaks of social unrest by mapping the nations listening to the IMF and waiting 2 years. Whereas the most successful nations ignored the IMF, and made every effort to avoid needing its “help”.

Still we should give the IMF staff credit for trying as best they can within the limits of today’s economic knowledge. Unlike the advice they’ve given so many times in the past, nothing in this prescription can hurt and most will help. However I suspect before this cycle ends economists will reach out for far more unorthodox solutions.

(5)  For More Information

Books about these things: Are we Doomed to Secular Stagnation?: Limitations of Supply-Side Economic Policies by Uwe Petersen (2014) and the highly rated Secular Stagnation: Facts, Causes and Cures by editors Richard Baldwin and Coen Teulings (2014).

If you liked this post, like us on Facebook and follow us on Twitter. See all posts about secular stagnation, and especially these posts:

1. Has America grown old, and can no longer grow? Or are wonders like the singularity in our future?
2. Why America’s growth is slowing, and a solution — Imagine bringing June Cleaver from her 1957 home to today’s equivalent; she’d be astonished at our lack of progress.  Look at how we’ve underperformed futurist Herman Kahn’s 1967 expectations for the year 2000.
3. Ben Bernanke sees the great slowdown in technological progress.
4. Larry Summers gives us the bad news. Worse, the only solution is more of the same.
5. Looking at America’s future: economic stagnation, or will computers take our jobs?
6. Dreams of a boom fade & attention turns to secular stagnation.
7. Do we face secular stagnation or a new industrial revolution?