Second, manifestly unsustainable bubbles and loosening of credit standards during the middle of the past decade, along with very easy money, were sufficient to drive only moderate economic growth.
Third, short-term interest rates are severely constrained by the zero lower bound: real rates may not be able to fall far enough to spur enough investment to lead to full employment.
Fourth, in such situations falling or lower-than-expected wages and prices are likely to worsen performance by encouraging consumers and investors to delay spending, and to redistribute income and wealth from high-spending debtors to low-spending creditors.
The presumption that normal economic and policy conditions will return at some point cannot be maintained. Look at Japan, where gross domestic product is less than two-thirds of what most observers predicted a generation ago, even though interest rates have been at zero for many years. It bears emphasis that Japanese GDP was less disappointing in the five years after the bubbles burst at the end of the 1980s than U.S. GDP has been since 2008. U.S. GDP is more than 10 percent below what the Congressional Budget Office predicted before the financial crisis.
If secular stagnation concerns are relevant to our economic situation, there are profound policy implications. But before turning to policy, two central issues regarding the thesis of secular stagnation have to be addressed.
First, is not a growth acceleration in the works in the United States and beyond? There are certainly grounds for optimism: recent statistics, the strong stock markets and the end — at last — of sharp fiscal contraction. Fears of secular stagnation were common at the end of World War II and were proved wrong. Today, secular stagnation should be viewed as a contingency to be insured against — not a fate to which we ought to be resigned. Yet the achievement of escape velocity has been around the corner in consensus forecasts for several years and we have seen several false dawns — just as Japan did in the 1990s. More fundamentally, even if the economy accelerates next year, this provides no assurance that it is capable of sustained growth at normal interest rates. Forecasts for growth in Europe and Japan are at levels well below that of the United States. Across the industrial world, inflation is below target levels and shows no signs of picking up — suggesting a chronic shortfall in demand.
Second, why shouldn’t the economy return to normal after the effects of the financial crisis are worked off? Is there a basis for believing that equilibrium real interest rates have declined? There are many reasons the level of spending at any given set of interest rates probably will have declined. Investment demand may have been reduced because of slower growth in the labor force and perhaps slower productivity growth. Consumption may be lower because of a sharp increase in the share of income held by the very wealthy and the rising share of income accruing to capital. Risk aversion has risen as a consequence of the crisis and as saving — by both states and consumers — has risen. The crisis increased the costs of financial intermediation and left major debt overhangs. Declines in the cost of durable goods, especially those associated with information technology, mean that the same level of saving purchases more capital every year. Lower inflation means any interest rate translates into a higher after-tax rate than it did when inflation rates were higher; logic is supported by evidence. For many years now, indexed bond yields have trended downward. Indeed, U.S. real rates are substantially negative at a five-year horizon.
Some have suggested that a belief in secular stagnation implies the desirability of bubbles to support demand. This idea confuses prediction with recommendation. It is, of course, better to support demand by supporting productive investment or highly valued consumption than by artificially inflating bubbles. On the other hand, it is only rational to recognize that low interest rates raise asset values and drive investors to take greater risks, making bubbles more likely. The risk of financial instability provides yet another reason why preempting structural stagnation is profoundly important.