In a much commented-upon speech at the IMF’s annual research conference last November, Laurence H. Summers, the former US Treasury Secretary and a candidate at the time for the chair of the US Federal Reserve, suggested we take very seriously the idea that developed economies will not see a rapid return to pre-crisis growth rates. They may well be following the same roadmap that traces the demise of Japan’s economy since 1990, he warned. There are a number of observations that I believe support such an analysis.
First, it is clear now that the recovery from the Great Financial Crisis of 2007-08 has been distinctly anaemic. In the US, the share of adults in work has not risen at all (as part of a so-called jobless recovery) and GDP is still declining relative to the pre-crisis trend rate of growth. In the last five years, America’s economy has grown by only 5.5% relative to its pre-crisis peak.
Second, many policymakers now recognise that, prior to the crisis, monetary policy was too lax, particularly in the US and the UK. Imprudent lending abounded and money was easy. Yet this very accommodative monetary policy neither triggered an economic boom, nor was industrial capacity utilisation under any great pressure. Unemployment was not particularly low and inflationary pressures were conspicuous only by their absence.
Finally, in the pre-crisis years, long-term real (inflation-adjusted) interest rates reached historic lows despite strong global economic growth. Yields on long-dated inflation-proof bonds fell to below 2% before the financial crisis and then below zero after the financial crisis in the US, the UK and France. At the end of the 1990s, real rates had been much higher, often well above 3%.
Could this substantial decline in real rates be explained in terms of a shift in the balance between desired saving and investment at the global level? Prior to the financial crisis, economists were already discussing evidence that a shift in overall global savings might have occurred and driven down real rates of interest worldwide.
To put things simply, a rise in total world savings would mean that the cost of savings (the real rate) falls. Summers asks us to envisage the idea that the short-term interest rate consistent with full employment might have fallen to -2% or -3% in the last decade. The idea of a ‘global savings glut’ – whereby an excess of savings combined with an absence of productive investment opportunities led to the drop in real interest rates – could constitute part of the explanation for this state of affairs.
Such an excess of savings would signify a long-standing structural weakness in the global economy, similar to the “global imbalances” – a world economy where current account surplus countries (e.g. emerging Asia and particularly China) supply more savings to the rest of the world than businesses could constructively use, even at very low interest rates.
In this context, excess savings would become a constraint on demand. Moreover, as the glut of savings reflects weak investment, it suggests prospective supply growth will be slow.
The conclusion to this hypothesis is that, while policymakers may have won the battle with the crisis (there has not been, as post-1929, a Great Depression), they have not won the war to rebalance an excess of savings relative to investment. Until they do, developed economies are confronted with the prospect of chronically weak growth and correspondingly weak returns from investments. Under this scenario, fretting about which assets classes are overbought is not the issue. What matters is how financial objectives can be achieved in a low return regime – it probably involves saving more.
Solutions could include inflation to engineer sufficiently negative real interest rates. Politically, such a solution may simply not be feasible. An alternative would be to use excess savings to finance large-scale public investment projects.