The Impact of Secular Stagnation

July 05, 2016 3 min read

By Lily-Elizabeth Hollings, Hurstpierpoint College, Alumnus of The Young Investment Banker Programme 2015

Secular stagnation, a concept first addressed by Alvin Hansen, and more recently by Larry Summers is becoming much more prominent in today’s economy. The purpose of this article is to examine the impact of secular stagnation on monetary policy alongside the structure of the financial sector. This rising issue is crucial to my generation, as it will have a large impact on future unemployment and the state of the economy. With the UK’s interest rate still standing at 0.5%, 8 years after the financial crisis, it has to be asked whether the prospect of persistently slow economic growth could actually be a long-term reality? Confidence levels fell hugely after the crisis and are still yet to return to where they were pre-2008. As a result, there has been under-investment in developed economies leading to a fall in productive potential especially within the industrial sector. I think that without high levels of investment and innovation it’ll cause a fall in dynamic efficiency along with a fall of global competitiveness in the long term, as exporting industries suffer this will further add to unemployment levels. An imbalance of excess savings in the rich economies and a lack of demand for investment will lead to downward pressure on real interest rates. The reason for this is, as the level of investment is low, the actual real interest rate has exceeded the negative equilibrium real interest rate, which is the natural rate. This now means that the global economy is suffering from a negative real interest rate which has existed for over 10 years, with the UK’s currently standing at -1.2%. Thus my question is: what does increasing secular stagnation alongside already low interest rates mean for future monetary policy?

Monetary policy is becoming ineffective, partly due to the liquidity trap, as injections into the economy by the central bank are only leading to asset bubbles instead of long-term growth. This is because of the severe lack of demand for investment opportunities in the real economy, adding to the problem of excess capital in the banks. Thus I think that trying to artificially create demand to solve such an issue will be unsuccessful and in this scenario an expansionary monetary policy, which has been implemented, is not working. This adds to my point in that as interest rates are already low there is limited movement to further decrease them in an attempt to increase investment levels; real interest rates are negative and so banks will be restricting who they lend out to and quantitative easing has been exhausted and has not proven to be overly successful. As a result I’d suggest less of a focus on using monetary policy for growth but instead use it to focus on avoiding an economic slowdown and combine that with measures that can adapt to intense expansionary fiscal policy as the economy implements Keynesian strategies. By and large, when my generation reaches the age of employment and I enter the financial sector, it is likely that the role of monetary policy will be diminished. Whereas other means, such as structural reforms i.e. the ring-fencing of core UK financial services and facilities to avoid market uncertainty will be in place. Consequently the whole dynamics of the financial sector could be altered in as little as 5 years to avoid secular stagnation, which will make working within this sector extremely interesting as the economy faces imminent changes.

Leave a comment

Comments will be approved before showing up.