This speech compares and contrasts two different interpretations of the current plight of the global economy. It argues that the world has been suffering not so much from a structural deficiency in aggregate demand—secular stagnation—but from the aftermath of financial booms gone wrong—financial cycle drag. This perspective suggests that the very low levels of interest rates that have prevailed are not necessarily equilibrium ones—consistent with the “natural rate”. And although it indicates that the headwinds from the financial bust, while very persistent, are temporary, it also points to a number of material risks ahead: further episodes of financial distress, a “debt trap” and, ultimately, a rupture in the open global economic order. To limit these risks, policies should be rebalanced towards structural measures and address more systematically the financial cycle.
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By “traditional” business cycle, I mean how economists and policymakers conceive and measure the typical fluctuations in output, as reflected in the specific statistical techniques (e.g. statistical filters). The notion of the financial cycle has a long historical tradition (see Drehmann et al. 2012 for references) and, as noted, was stressed again in BIS work going back at least to the early 2000s. For other empirical evidence on the financial cycle, see, e.g., Claessens et al. (2011), Aikman et al. (2015), De Bonis and Silvestrini (2014), Schüler et al. (2015), Einarsson et al. (2016) and Rünstler and Vlekke (2016).
See the BCBS (2010) survey and, in particular, Cerra and Saxena (2008) and, more recently, Ball (2014). Blanchard et al. (2015) find that other recessions too may have a similar effect. On the costs of credit booms in general, see Reinhart and Reinhart (2010), Jordà et al. (2013) and Mian et al. (2015); and on the experience of the Great Depression, see Eichengreen and Mitchener (2004).
On the role of globalisation in driving inflation, see Borio and Filardo (2007) and BIS (2014). For empirical studies reaching similar conclusions, see, e.g., Bianchi and Civelli (2013), Ciccarelli and Mojon (2010), Eickmeier and Moll (2009) and Pain et al. (2008); for others that disagree, see, e.g., Ihrig et al. (2010), Martínez-García and Wynne (2012) and Lodge and Mikolajun (2016).
This phenomenon has been greatly boosted by technology, which has allowed the relocation of production to lower-cost countries; see Baldwin (2016).
On some of the difficulties with this approach, see also Taylor and Wieland (2016). A second set of approaches assumes that the trend of the (long-term) rate tracks the natural rate and tries to explain it with reference to structural factors, such as demographics (e.g. Gagnon et al. 2016), generally not by estimating the link but showing that a calibrated model could reproduce the observed path.
That said, on the pitfalls in interpreting long-term yields as reflecting “market” expectations, see Shin (2017).
In a similar vein, Blanchard et al. (2017) argue that the low growth post-crisis has partly reflected temporary factors such as agents’ pessimism about future growth potential, in turn reflected in long-term yields that are too low compared with true growth prospects.
To be sure, lower interest rates can still sustain expenditures to the extent that they reduce debt service burdens and hence generate resources to repay debt. The point is that agents that realise they have borrowed too much would give priority to balance sheet repair and debt repayment, so that additional income would tend to be saved rather than spent, regardless of any restrictions on the supply of credit (Borio 2014a). On this, see also Koo (2003), who was the first to use the term “balance sheet recession”. While bearing some obvious similarities with his use of the term, the notion of a balance sheet recession here leads to somewhat different policy conclusions; see Borio (2014a) for a further elaboration. See also Bech et al. (2014) for empirical evidence on the importance of deleveraging and on the more muted effectiveness of monetary policy in the context of balance sheet recessions.
The mechanisms are discussed in detail in, e.g., Borio and Disyatat (2011), Borio (2014b), Shin (2012), Bruno and Shin (2014) and McCauley et al. (2015). See also Rey (2013) for the notion of a global financial cycle and Hofmann and Bogdanova (2012), updated in BIS (2016), for evidence that globally policy interest rates are unusually low compared with traditional benchmarks.
Between 2009 and the third quarter of 2016, US dollar credit to non-banks outside the United States increased by some 50%, to some $10.5 trillion, and it roughly doubled to those in emerging market economies alone, to around $3.6 trillion.
Rajan (2014) refers to this process as “competitive easing“.
It is often argued that such measures would depress demand, at least in the short term, and hence possibly make matters worse. But the empirical evidence suggests otherwise for a broad range of measures. See Bouis et al. (2012).
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I would like to thank Raphael Auer, Piti Disyatat, Dietrich Domanski, Andy Filardo, Jonathan Kearns, Marco Lombardi, Robert McCauley, Phurichai Rungcharoenkitkul, Hyun Song Shin and Fabrizio Zampolli for helpful comments.
Speech delivered at the NABE Economic Policy Conference, March 7, 2017.
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Borio, C. Secular stagnation or financial cycle drag?. Bus Econ 52, 87–98 (2017). https://doi.org/10.1057/s11369-017-0035-3
- Secular stagnation
- Financial cycle