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Economics / Review Essay

Vol. 4, NO. 4 / July 2019

Ten years ago, as the Great Recession drew to a close, the consensus among experts was that the losses incurred during the crisis would be absorbed quickly during a short period of strong recovery. In this, they were, no doubt, influenced by Kenneth Rogoff, who had just published a masterly study of the many financial crises since the Second World War. The greater the recession, Rogoff concluded, the stronger the recovery that followed.1 Nobody doubted that the same pattern would be repeated.

The recovery never arrived—not really. Growth has been positive but sluggish. During the eight years following the end of the recession, the average US growth rate was reduced by half. In Europe, aside from Germany, the GDP of the eurozone only returned to its 2007 level in 2016, nine years after the start of the crisis; the US required six years.

A comparison to the 1930s is even more telling. Despite the extent of the decline in European production during the Great Depression, 1929 levels were regained by 1935. In the US, the rate of recovery between 1933 and 1941 was twice that of the last eight years. From this point of view, the period following the most recent crisis should be seen as a quasi-stagnation, a breakdown of sorts, or even, at worst, a latent depression.

The Origins of Secular Stagnation

In 2011 and again at the end of 2014, American observers believed that the long-awaited recovery was finally underway. They were disappointed. Growth proved to be short-lived. If growth proved short-lived, not so optimism. The US media relies on the unemployment rate, currently at historically low levels, as the basis for believing in the possibility of a return to full employment. If so, there should be tell-tale signs of acceleration across a variety of indicators for more than a few exceptional quarters. This is not what has been observed. On the contrary, all the evidence suggests that what is taking place now is a third, and weakened, repetition of what has already happened twice.2

Why do we seem to be stuck in this long period of slow growth?

Lawrence Summers has offered the most popular explanation, appealing to ideas first formulated by Alvin Hansen in the aftermath of the 1937 recession.3 Hansen was largely responsible for popularizing the ideas of John Maynard Keynes, and, as such, is an important, although little-known, figure in the history of economics. Hansen believed the great stagnation of the interwar period was due to an exhaustion of the three main drivers of American growth during the nineteenth century: territorial expansion, population growth, and technological innovation. When economic expansion returned during the 1950s, Hansen’s predictions were quickly forgotten. If Hansen had been mistaken, Summers argued, it had only been because he was several generations ahead of his time.

According to Summers, the single most important economic indicator of the current era is the declining trend in interest rates. Without this decline, nothing that has occurred since 2007 would have taken place. Rates are today close to zero, the result of a process that began in the late 1980s. Although the actions of central banks have played a role in depressing interest rates, three long-term structural factors are of greater importance: an aging population and declining birth rate; increasing income and wealth inequality; and a decline in the relative cost of capital. Although Summers does not mention it directly, there is a fourth factor that should be added to this list: the slowdown in productivity since the 1970s. This has been documented statistically by Robert Gordon, who regards the slowdown as a point in Hansen’s favor.4 These four factors are very much in keeping with the spirit, if not the details, of Hansen’s analysis.

Summers has suggested that this combination of long-term factors has led to a deficit in aggregate demand that is likely to continue beyond the short term. This deficit had long been disguised by an increasing indebtedness among households, businesses, and public authorities. These groups artificially maintained their levels of consumption at the cost of colossal financial imbalances, which made it inevitable that some bubble or other would eventually burst. In theory, changes in interest rates during the crisis should have then led to a reset and a fresh start. As it turned out, the excessively low levels of interest rates effectively neutralized this mechanism. Borrowers kept borrowing.

During the early twentieth century, Knut Wicksell argued for the importance of a natural interest rate. If nothing else, a natural rate would make it possible to define an equilibrium state for the economy corresponding to normal growth. That equilibrium defined, interest rates could be changed, either to slow down the economy, or to revive it. Despite it serving as a compass, of sorts, for monetary policy, we have no empirical means of knowing precisely what a natural interest rate might be. In response to this problem, the central banks have developed rules of thumb for managing rates from inflationary trends. If inflation is increasing, interest rates are too low. Conversely, if inflation is trending downwards and approaching zero, interest rates are too high.

When nominal rates are already close to zero, adjustment mechanisms no longer work. This was the case at the end of the Great Recession, and inflation has continued to decline ever since. If interest rates became negative, economic players would have every incentive to hoard their wealth in cash instead of using it to refinance the economy. This scenario is known as a liquidity trap—the traditional tools of monetary intervention are rendered ineffective in an economy hamstrung by low inflation and lasting stagnation.5

These are the circumstances, Summers is persuaded, into which the developed capitalist economies have gradually settled since the crisis. There is only one possible solution: largescale state intervention in the form of major works and massive public investment in order to boost global demand. The twin perils of the liquidity trap and excessive debt would be overcome by a return to higher rates of inflation. If these policies are not instituted, there is little point hoping for a miracle. The risk of a new and even deeper financial crisis will be ever-present, and the world will have to become accustomed to a new era of slow growth, or secular stagnation. It is this scenario that Summers, along with Paul Krugman and others, feel best reflects the economic breakdown observed since 2008.

The BIS versus Summers

The influence of these ideas can be clearly seen in the medium-term forecasts published by the US Congress Budget Office and the US Federal Reserve Board. The specter of secular stagnation has shaped their vision of the future. Even the venerable Banque de France recently organized a symposium devoted to this theme.6 Nonetheless, this view is the subject of intense controversy among economists, particularly those working at the Bank for International Settlements (BIS) in Basel, the world’s oldest international financial organization.7 The BIS is owned and operated by 60 central banks and monetary authorities.

The rise of the internet and the information economy, Jean-Pierre Chamoux observed, has had a deforming effect on statistical economic analysis based on traditional industrial economies.8 Unless adapted for this new era, existing measurement and accounting tools may no longer provide a reliable image of economic activity. As the Brookings Institution has pointed out, this is reason enough to question the veracity of the productivity data relied upon by Summers and Gordon.9

Mainstream views of the economy are based on a number of hypotheses around which there is a genuine consensus in academic circles. These are now being contested, both by researchers favoring alternative frameworks and by the BIS. Consider the neutrality of money. Contemporary models assume that the effects of monetary policy are transitory. The dynamics of medium- and long-term economic processes are exclusively dependent on a set of real variables: demography, investment, savings, productivity, and so on. Money is seen only as an artifact that conceals underlying dynamics, but not an integral part of them. This explains why even the most complex and detailed current macroeconomic models do not consider financial data essential to the activities of most corporations.

The neutrality of money is a thesis now in doubt. In considering the last decade, the Economic and Monetary Analysis Department at the BIS studied whether econometric models can be enriched by including monetary and financial data among the equations describing credit, indebtedness, asset prices, or the structure and evolution of balance sheets. This work has shown that models augmented in this manner would have identified in advance the increasing financial imbalances that triggered the 2008 crisis.10 This is, of course, a remarkable result. It has also led to the accumulation of a considerable body of data, the analysis of which has cast doubt on the basis for the secular stagnation scenario advanced by Summers.

The natural interest rate is a purely virtual value: it must be measured by means of complex calculations deduced from a theoretical model. Economists at the BIS have shown that an econometric model incorporating their additional monetary and financial indicators leads to a new view of the natural rate. It should be significantly higher than it is, and not, in any case, negative, as Janet Yellen has suggested—based on studies by the Federal Reserve Bank of San Francisco.11 The liquidity trap, which plays such a central role in the arguments advanced by both Summers and central banks to justify monetary policy choices, should be much less restrictive than previously imagined.

At a lecture in September 2017, the BIS group’s leader, Claudio Borio, revealed the results of an unpublished study aimed at empirically verifying whether traditional quantitative factors—such as demography, growth, productivity, income inequality, relative price of capital, and marginal product—were sufficient to account for the evolution of real interest rates in 19 countries over a period of nearly a century and a half. Such a hypothesis plays a central role in contemporary neo-Keynesian theory, which leads to the notion of an abstract interest rate toward which all rates would eventually converge in the long term—say, a decade or so.12 This relationship works relatively well from a starting point in the 1980s, around the time when the current trend of falling rates began. The same cannot be said for longer timescales, for which there is no statistically significant correspondence between the aforementioned factors and the evolution of real rates. If Borio and his team are correct, this finding strikes at the heart of the analysis used by the central banks. It also runs counter to the arguments made by experts like Rogoff. Above all, it has critical implications for secular stagnation.

The Phillips curve plays a central role in the formulation of contemporary economic policies at the US Federal Reserve. If an assumed natural interest rate is defined by reference to a hypothetical situation of full employment, a tool is still needed to determine how the economy is performing with respect to that goal. That tool is the Phillips curve, which establishes the relationship between employment and inflation.13 The reliability of this relation is crucial if it is to play any meaningful role in policy-making. From studies of the G7 countries, economists at the BIS have shown that traces of such a relation, when they can indeed be found, are far more tenuous and elusive than widely believed. This is particularly true when the data being analyzed covers the last few decades and the period of increasing globalization.14

The BIS has also cast a critical eye toward deflation. Is it true that any decline in prices is necessarily a bad thing for growth? It would appear not. In examining this question, the BIS undertook an enormous historical survey encompassing 38 countries over a period of more than 140 years.15 The BIS team found only an extremely weak correlation between decay and deflation. An exception was the Great Depression of the 1930s, the specter of which continues to play on the minds of contemporary economists. The BIS researchers found no empirical evidence in favor of Irving Fisher’s theory of debt deflation—even during the period covered by the Great Depression.16

The notion of a global savings glut plays a prominent role in current macroeconomic theory—a theory endorsed by Summers and three past chairs of the US Federal Reserve: Alan Greenspan, Ben Bernanke, and Janet Yellen. This theory is closely linked to a conception of the international economy based on longstanding economic, accounting, and legal conventions that have been rendered anachronistic by the financial and economic effects of globalization.17 Nonetheless, economists continue to use models in which everything is reduced to problems of surplus or deficit trade balances, which are balanced and rebalanced by adjusting parities between currencies. International statistics are collected solely on the basis of residence: the movements of funds from the subsidiary of a large French bank in New York are considered as imports or US capital exports, even for purely internal transactions.

Since the early 2000s, one of the most important projects undertaken by the BIS has been to rebuild international exchange accounts on the basis of nationality: the internal movements of a transnational group are consolidated with the accounts of the country where its head office is located. This led the BIS to develop a matrix of global monetary flows that revealed a hitherto unnoticed phenomenon—a colossal rise in the volume of interbank trade since the end of the 1990s. This rise reflected the growing internationalization of banking and financial activities, which are becoming increasingly independent of the territorial limits of the old national money markets.

According to Hyun Song Shin, a member of the Economic and Monetary Research Department at the BIS, this phenomenon, which he describes as a global banking glut, played a crucial role in triggering the financial crisis of 2007–2008.18 This crisis, he explains, had little to do with the savings of China, Japan, or Germany. It was the extraordinary interbank transfers introduced in previous years by large European banks that acted to prime the system for destruction. Those transfers were used to obtain liquidity from the US money market funds to buy US subprime mortgages. The crisis was triggered by an accumulation of imbalances introduced into European bank balance sheets by this cross-Atlantic traffic.19 At the time, there were no financial instruments capable of detecting these developments.

A New Monetary Banking Order

The BIS has been wonderfully useful in rethinking and reconstructing the global map of cross-border monetary flows. This research has revealed the existence of unsuspected empirical relationships. It turns out that large movements in the value of the dollar, either downward or upward, are much more a function of the growth or decay of global bank and non-bank credit flows than the state of the world economy, the US trade balance, or monetary decisions taken to reduce the deficit.20 The so-called imperial status of the dollar has become a trap that has robbed the US of its effective monetary independence. This can be seen in the extraordinary difficulties faced by the US Federal Reserve in attempting to implement its monetary normalization and rate hiking projects.

There are also other reasons to emphasize the work being done by the researchers at the BIS. As a result of their labors, economists and researchers now have the empirical raw material needed to fully appreciate the degree to which the industrial and commercial globalization of the last thirty years has radically transformed the nature and functioning of the international monetary system. Most mainstream economists continue to describe the world economy using theoretical frameworks that have little connection with the true nature of contemporary banking. BIS economists have also developed new observation and warning instruments that should enable monetary managers to act preemptively to address the formation of major imbalances, a factor of financial instability.

The BIS team does not hold back when assessing the performance of the central banks and the ideas that inform their decisions. Their analyses also suggest further critiques—namely, that the current failure in growth can be attributed, at least in part, to the blindness of the central banks to a new emerging monetary banking order.21 On this particular question, the economists in Basel could be far more explicit.

Translated and adapted from the French by the editors.


  1. Kenneth Rogoff and Carmen Reinhart, This Time Is Different: Eight Centuries of Financial Follies (Princeton: Princeton University Press, 2009). 
  2. It has been so long since there has been a real, old-fashioned economic recovery that the difference between a robust recovery and a simple slow-motion recovery has become blurred in media reporting. This can be seen when comparing the statistical data quoted in contemporary reports with those for comparable economic periods from the past. See, for example, daily columns published by Jeffrey Snider on the website of Alhambra Investment Partners. Comparisons of the main economic indicators—sales, employment, income, hours worked, retail expenditures, profits, exports, etc.—clearly show how much the reflation of 2017 is a pale imitation of mini-cycles already observed in 2011 and 2014. 
  3. Lawrence Summers, “Secular Stagnation and Monetary Policy,” Federal Reserve Bank of St. Louis Review 98, no. 2 (2016): 93–110; Lawrence Summers, “Reflections on Secular Stagnation” (speech, Julis-Rabinowitz Center, Princeton University, February 19, 2015). 
  4. Martin Anota, “Robert Gordon et la fin de la croissance américaine (Robert Gordon and the End of American Growth),” D’un champ l’autre, February 20, 2014. 
  5. There is also the threat of a drift toward an apocalyptic process of self-sustaining cumulative deflation according to the famous scheme described in the 1930s by Stanley Fischer, known as debt deflation. Central banks believed that they could get around this problem by using unconventional monetary tools such as massive asset purchases, a forward guidance policy (intended to communicate the medium-term intentions for the management of interest rates), or by penalizing the reserve deposits held by banks (see, for example, the negative rates applied by the European Central Bank and the Bank of Japan). The fact that inflation did not rise beyond a few exceptional months, as was the case in early 2017, demonstrates that this strategy has failed. 
  6. Banque de France, “La stagnation séculaire et mesure de la croissance (Secular Stagnation and Measuring Growth),” conference, Paris, January 16, 2017. See also a note from the European Parliament’s Research Service, which clearly shows that the problem of secular stagnation was on the minds of European economists. Gustaf Gimdal and Cemal Karakas, “Secular Stagnation and the Euro Area,” European Parliament Research Service, PE.573.972, February 2016. 
  7. Claudio Borio, “Secular Stagnation or Financial Cycle Drag?” (speech, National Association for Business Economics, Washington, DC, March 5–7, 2017). See also the arguments that Barry Eichengreen and Erik Brynjolfsson offer in response to the analyses of Robert Gordon. Barry Eichengreen, “Secular Stagnation: The Long View,” American Economic Review Papers and Proceedings 105, no. 5 (2015): 66–70; Erik Brynjolfsson and Andrew McAfee, Le Deuxième Âge de la machine: Travail et prospérité à l’heure de la révolution technologique (The Second Age of the Machine: Work and Prosperity in the Age of Technological Revolution) (Paris: Éditions Odile Jacob, 2014). 
  8. Jean-Pierre Chamoux, ed., L’ère du numérique 1: Enjeux des données massives (The Digital Age 1: The Challenges of Big Data) (London: ISTE Editions, 2017). 
  9. Martin Bailey and Nicholas Montalbano, “Why Is US Productivity Growth So Slow? Possible Explanations and Policy Responses,” Hutchins Center Working Papers, September 1, 2016. 
  10. See BIS, 86th Annual Report (2016), box IV.C: “The Financial Cycle, the Natural Interest Rate and Monetary Policy,” 98. For more details, see Mikael Juselius et al., “Monetary Policy, the Financial Cycle and Ultra-Low Interest Rates,” BIS Working Papers no. 569 (2016). The most complete data can be found in Iñaki Aldasoro, Claudio Borio, and Mathias Drehmann, “Early Warning Indicators of Banking Crises: Expanding the Family,” BIS Quarterly Review (2018). The BIS economists used six indicators: credit-to-GDP gap, property price gap, debt-service ratio, household-credit-to-GDP gap, household debt-service ratio, foreign currency debt, and cross-border claims. The tests were conducted using data from 42 countries between the first quarter of 1980 and the second quarter of 2017. 
  11. On the subject of persistently low and negative rates, see Mikael Juselius et al., “Monetary Policy, the Financial Cycle and Ultra-low Interest Rates,” BIS Working Papers no. 569 (2016). 
  12. Claudio Borio, “Through the Looking Glass” (speech, OMFIF City Lecture, London, September 22, 2017). 
  13. Described in 1958 by an economist at the London School of Economics, William Phillips, the Phillips curve shows a negative empirical relationship between the unemployment rate and the growth rate of nominal wages. The relationship between employment and inflation can also be determined from this work. 
  14. Claudio Borio writes:
    The link between measures of domestic slack and inflation has proved rather weak and elusive for at least a couple of decades now. True, if one tries hard enough, it is always possible to find it. But it is not the kind of relationship that jumps out at you and appears robust. … Graph 1 … shows that, for G7 countries, the response of inflation to a measure of labour market slack has tended to decline and become statistically indistinguishable from zero. In other words, inflation no longer appears to be sufficiently responsive to tightness in labour markets. Again, let me stress: one can [emphasis original] get statistically significant coefficients for some specifications, but the picture portrayed in the graph is quite typical. Moreover, it would have been starker had one used output-based, as opposed to labour market-based, measures of slack.
    Claudio Borio, “Through the Looking Glass” (speech, OMFIF City Lecture, London, September 22, 2017), 2–3. In a 2017 study, economists from the BIS explained the disappearance of the Phillips relationship as a consequence of industrial globalization. See Raphael Auer, Claudio Borio, and Andrew Filardo, “The Globalisation of Inflation: The Growing Importance of Global Value Chains,” BIS Working Papers no. 602 (2017). 
  15. Claudio Borio et al., “The Costs of Deflations: A Historical Perspective,” BIS Quarterly Review, March 18, 2015. 
  16. See the summary of this question given by Claudio Borio in his lecture “Revisiting Three Intellectual Pillars of Monetary Policy Received Wisdom” (speech, Cato Institute, Washington, DC, November 12, 2015), 5. 
  17. See the study by Claudio Borio and Piti Disyatat, “Global Imbalances and the Financial Crisis: Link or No Link?BIS Working Papers no. 346 (2011); George Selgin, “Less than Zero: The Case for a Falling Price Level in a Growth Economy,” IEA Hobart Paper no. 132 (The Institute for Economic Affairs, 1997). 
  18. See Hyun Song Shin, “Global Savings Glut or Global Banking Glut?VOX CEPR Policy Portal, December 20, 2011; Hyun Song Shin, “Global Banking Glut and Loan Risk Premium” (speech, 2011 IMF Annual Research Conference, Mundell-Fleming Lecture, Washington, DC, November 10–11, 2011). 
  19. See Claudio Borio and Piti Disyatat, “Global Imbalances and the Financial Crisis: Link or No Link?BIS Working Papers no. 346 (2011). 
  20. Hyun Song Shin has remarked:
    Interestingly the most recent period of dollar strength from mid-2014 has been associated with a decline in the aggregate cross-border liabilities. … When an international currency depreciates, there is a tendency for foreigners to borrow more in that currency [emphasis original]. … The precise mechanism will depend on the context, but the key feature of the risk-taking channel is that when the dollar depreciates, banks lend more in US dollars to borrowers outside the United States. Similarly, when the dollar appreciates [emphasis original], banks lend less, or even shrink outright the lending of dollars. In this sense, the value of the dollar is a barometer of risk-taking and global credit conditions.
    Hyun Song Shin, “Global Liquidity and Procyclicality” (speech, World Bank conference, “The State of Economics, The State of the World,” Washington, DC, June 8, 2016), 7, 9. 
  21. For more details, see Henri Lepage, “Système monétaire et banques centrales: la grande déglingue (Monetary System and Central Banks: The Big Ruse),” Arguments, September 17, 2017; Henri Lepage, “Le Ressort brisé du système monétaire international (The Broken Spring of the International Monetary System),” Politique Internationale 158 (2018). 

Henri Lepage is a French economist.

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