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Marie-Hélène Duprat
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Will the pandemic trap economies in secular stagnation?

Marie-Hélène Duprat, Senior Advisor to the Chief Economist at Société Générale

[This arti­cle is a sum­ma­ry of an in-depth analy­sis pub­lished at vari​ances​.eu, for the orig­i­nal arti­cle click here]

It is a rare event: in 2020, eco­nom­ic activ­i­ty in the devel­oped world fell by 5.3%. As such, the Covid-19 cri­sis could trap economies in “sec­u­lar stag­na­tion”, a pro­longed peri­od of slug­gish growth. Three fac­tors sup­port this hypoth­e­sis: a decline in poten­tial out­put, changes in house­hold and busi­ness behav­iour, and the accel­er­a­tion of the dig­i­tal tran­si­tion, which is a major fac­tor in inequality.

His­to­ry shows that deep reces­sions often have last­ing con­se­quences on the main macro­eco­nom­ic vari­ables (GDP, pro­duc­tiv­i­ty, unem­ploy­ment), even after the ini­tial shock has ful­ly dis­si­pat­ed. This is known as “hys­tere­sis”: the phe­nom­e­non that caused the cri­sis (in this case the pan­dem­ic) dis­ap­pears, but the cri­sis con­tin­ues in the long term. 

This hys­tere­sis effect will play a par­tic­u­lar­ly impor­tant role in the case of work­ers who have been thrown out of work by numer­ous bank­rupt­cies. If the work­ing pop­u­la­tion has been spared the virus, which main­ly affects old­er peo­ple, then mass redun­dan­cies could result in a loss of employ­a­bil­i­ty of work­ers, who would then strug­gle to find a job after the cri­sis. But the adverse effects will also affect phys­i­cal cap­i­tal accu­mu­la­tion and productivity.

The effec­tive low­er bound on rates 

Many devel­oped economies entered this cri­sis in a vul­ner­a­ble state, with his­tor­i­cal­ly low inter­est rates and huge debt bur­dens. Since the sub­prime mort­gage cri­sis, cen­tral banks low­ered pol­i­cy rates to almost zero and resort­ed to uncon­ven­tion­al poli­cies (notably quan­ti­ta­tive eas­ing). But this did not trans­late into a sat­is­fac­to­ry recov­ery in activity. 

The eco­nom­ic rebounds were mod­er­ate and tem­po­rary, while under­ly­ing infla­tion remained stub­born­ly low, long-term inter­est rates con­tin­ued their down­ward trend, and stock mar­ket val­u­a­tions rose. Over­all, mon­e­tary pol­i­cy since 2008 has paved the way for the accu­mu­la­tion of finan­cial vul­ner­a­bil­i­ties – explod­ing lever­age, exces­sive risk-tak­ing, asset bub­bles – with­out pro­vid­ing a sus­tain­able boost to activ­i­ty. And the Covid-19 cri­sis threat­ens to accen­tu­ate this dynam­ic. The cen­tral banks are now cor­nered: it is impos­si­ble for them to con­tin­ue low­er­ing their rates.

Source : Refinitiv

The inter­est rate that cen­tral bankers seek to achieve is the ‘nat­ur­al’ inter­est rate – the the­o­ret­i­cal real inter­est rate at which the econ­o­my is nei­ther infla­tion­ary over­heat­ing nor defla­tion­ary depres­sion. It is esti­mat­ed that this rate has fall­en over the last few decades to the point where it is close to zero, mak­ing con­ven­tion­al mon­e­tary poli­cies inef­fec­tive. The expla­na­tion for this decline lies in the imbal­ance between too much sav­ing and too lit­tle investment. 

The cur­rent excess of sav­ings is part­ly due to the increase in inequal­i­ties – the mar­gin­al propen­si­ty to save of the most for­tu­nate being clear­ly high­er than that of the least for­tu­nate – but also to the efforts to reduce debt made since 2008, as well as to the age­ing pop­u­la­tion (old­er peo­ple hav­ing a greater ten­den­cy to save in antic­i­pa­tion of their retire­ment). The fall in busi­ness invest­ment is, for its part, main­ly a con­se­quence of the weak­en­ing of growth poten­tial, syn­ony­mous with a decline in future real returns on investment. 

The sec­u­lar stag­na­tion hypoth­e­sis assumes that cen­tral bank pol­i­cy rates will remain so low that cen­tral banks will fre­quent­ly be unable to reduce them suf­fi­cient­ly to com­bat reces­sions effec­tive­ly. Con­strained by the effec­tive low­er bound on rates, the econ­o­my can only move towards full employ­ment if gov­ern­ments increase the gov­ern­ment deficit or if mon­e­tary pol­i­cy becomes high­ly expan­sion­ary, encour­ag­ing the dis­tri­b­u­tion of cred­it and the rise in asset prices that become the engine of growth. 

An econ­o­my suf­fer­ing from sec­u­lar stag­na­tion is not going to remain per­ma­nent­ly stag­nant. But the under­pin­nings of growth – the inflat­ing debt and asset price bub­bles – increase the economy’s vul­ner­a­bil­i­ty to crises. Decline in activ­i­ty due to crises become stronger and longer than recov­er­ies, mechan­i­cal­ly low­er­ing aver­age GDP growth.

Risk aver­sion 

The Covid-19 cri­sis is like­ly to aggra­vate the prob­lem of excess sav­ings. One rea­son for this is that “extreme” risk events – also known as “black swans” in the finan­cial sec­tor – often lead to a chal­lenge to old belief sys­tems. As econ­o­mists have point­ed out, “The great­est eco­nom­ic cost of the Covid-19 pan­dem­ic may be the result of behav­iour­al changes that per­sist long after the imme­di­ate res­o­lu­tion of the health cri­sis 1.”

The seis­mic shock of the pan­dem­ic could result in a struc­tur­al increase in risk aver­sion of firms and house­holds, lead­ing to a reduc­tion in their invest­ment and con­sump­tion spend­ing, in order to build up a larg­er sav­ings cush­ion for future crises. A fall in con­sump­tion, which means few­er oppor­tu­ni­ties for com­pa­nies, gen­er­al­ly results in a fall in invest­ment. More­over, the inclu­sion of epi­demi­o­log­i­cal risk is like­ly to increase the risk pre­mi­um required to jus­ti­fy cer­tain pro­duc­tive invest­ments, fur­ther curb­ing the accu­mu­la­tion of phys­i­cal capital. 

Increas­ing inequal­i­ty and the dig­i­tal revolution

Covid-19 could also con­tribute to sec­u­lar stag­na­tion by exac­er­bat­ing socio-eco­nom­ic inequal­i­ties. The sec­tors most affect­ed by the cur­rent cri­sis are those employ­ing an irreg­u­lar work­force (such as the hotel indus­try). But the expo­nen­tial devel­op­ment of the dig­i­tal econ­o­my since the begin­ning of the pan­dem­ic is also a vec­tor of inequal­i­ty, for two main rea­sons: it favours high­ly qual­i­fied work­ers (this is known as « skill-biased tech­no­log­i­cal change »), and leads to the robo­t­i­sa­tion of rou­tine tasks, which were main­ly car­ried out by low- or medi­um-skilled labour. 

How­ev­er, as the most afflu­ent are those with the high­est propen­si­ty to save, the phe­nom­e­non of excess pri­vate sav­ings at the ori­gin of the fall in the nat­ur­al rate of inter­est should become even worse.

Nev­er­the­less, sec­u­lar stag­na­tion is not an evil with­out a rem­e­dy: fis­cal pol­i­cy has an impor­tant role to play in its res­o­lu­tion, by absorb­ing excess pri­vate sav­ings via an increase in pub­lic deficits 2. More­over, the dig­i­tal trans­for­ma­tion could result, as some pre­dict, in a pro­duc­tiv­i­ty boom that would boost eco­nom­ic growth.

1Kozlows­ki, Julian, Lau­ra Veld­kamp et Venky Venkateswaran, « Cica­tri­sa­tion du corps et de l’esprit : les effets à long terme de la COVID-19 sur la cica­tri­sa­tion des croy­ances », NBER Work­ing Paper Series, WP n° 27439, 2020
2Olivi­er Blan­chard et Lawrence Sum­mers, éd., Évo­lu­tion ou révo­lu­tion ? Repenser la poli­tique macroé­conomique après la Grande Réces­sion, MIT Press, 2019

Contributors

Marie-Hélène Duprat
Marie-Hélène Duprat
Senior Advisor to the Chief Economist at Société Générale

After starting her career as an economist at the French Institute of International Relations (IFRI), Marie-Hélène Duprat worked as an economist at Crédit National (now Natixis), the International Monetary Fund (IMF) and the World Bank. She has held various positions within the Société Générale Group and holds a PhD in economics from the University of Paris 1 Panthéon-Sorbonne and is a graduate of Sciences Po Paris. Marie-Hélène has also been a visiting scholar at the Massachusetts Institute of Technology (MIT).