Is the World Still at Risk of The "Japan Disease"?

THREE YEARS AGO, TIE asked this question:

To what extent can the global picture of 2017 be described in one sentence: Significant parts of the world are at risk of becoming more like Japan. In other words, the world's public and private debt today is approaching 300 percent of GDP. Yet despite an extraordinary degree of monetary expansion and relatively tight labor markets, a number of central bankers are finding it tough to meet their inflation targets. Meanwhile, wage growth remains modest. Productivity gains are disappointing. As Japan has done in recent years, some central bank authorities, including those in China, are purchasing equities to stabilize stock markets. Has the world been afflicted with a kind of 'Japan disease' ?

Now, with the world economy in meltdown as a result of the coronavirus, are large parts of the world about to fall into an extended low-growth funk, weighed down by unheard of levels of debt, disinflationary pressures, a non-stimulative monetary policy, low productivity, and an aging population?

More than thirty expert analysts tackle the question.

JEAN-CLAUDE TRICHET

Former President, European Central Bank

When looking at the present extraordinary situation created by the global pandemic, there is the temptation to take the worst global crisis in a century as a single event which would per se dramatically change the course of the global economy. In my opinion, it might be more enlightening to see it as the addition of two major layers: first, the weak state of the economy before the pandemic; and second, the particular impact of the pandemic applied on the pre-pandemic situation. Before the pandemic, the global situation was already worrying.

First, after the 2008 financial crisis, loose macro policies were pursued in many countries. In particular, several advanced economies posted persistent structural current account deficits, erratic fiscal policies, and timid structural reforms. Many emerging economies embarked on massive indebtedness.

Second, in all countries the main burden was on the shoulders of the central banks, with the other stakeholders, including governments, parliaments, the private sector, and social partners, standing back.

Third, new public and private debt piled up. The consensus is that additional global outstanding public and private debt of an order of magnitude of 40 percent of global GDP was added from 2008 to 2019. What a paradox when it was obvious that the Great Financial Crisis was itself caused by over-indebtedness!

Fourth, the level of investment was abnormally weak in many economies, particularly in the advanced countries.

Fifth, due to a combination of low investment, poor demographics, and a drop of total factor productivity since 2005, economic growth was low.

Sixth, previous factors combined to produce low unit labor cost growth, amplified by weakening of bargaining power of labor, low inflation, and the abnormally low level of nominal interest rates, pushed down by very low neutral rates.

All this was observed before the pandemic. This is not to say that everything was negative. Job creation had made progress in many advanced and emerging economies. Science and technology were making more advances than ever. There were some reasons to think that total factor productivity could be on the rise again in the future, and there were signs that labor would call for more dynamic growth of wages and salaries.

But the bottom line was that the global economy was in a vulnerable financial and economic situation before the virus breakout.

Applied to this pre-pandemic situation, what is the specific impact of the exogenous coronavirus? I see three dimensions.

First, on a short- and medium-term basis, the pandemic alone triggers an artificial "economic coma," a crisis which is the gravest since World War II. There is no doubt that it will be much graver because the previous economic and financial situation was weak.

Second, on a longer-term basis, the virus crisis is a strong call for reinforcing resilience through sound economic, fiscal, financial, and structural management, and risk optimization at national, continental, and global levels, including in terms of diversification of sources of supply. Resilience also means setting up social safety nets and reinforcing social cohesion so that exogenous shocks do not destroy societies.

Third, the present crisis is a strong wakeup call on international cooperation. A pandemic is global by definition: the virus is attacking all members of the human species without exception. Pandemics call for global response for the sake of humanity. It was a pity that at the very beginning of the crisis, the international community was quasi absent due to the spread of national populism in both the advanced and the emerging countries. There was no early mobilization of the G20 (contrary to 2008). Renewed multilateralism is more important than ever if we want global public goods to be preserved, in particular global public health, climate change mitigation, and economic and financial stability.

The main lesson to be drawn from the present crisis is that resilience and sustainability should always be of the essence in all domains of human activity. And as regards economy and finance, whatever the enormous difficulties we face with the cost of the crisis, the mottoes should be "Do not let central banks act alone in the future as was the case in the past," and "Do not forget that sound macro policies are the best vaccine against future instability."

JACQUES DE LAROSIERE

Former Managing Director, International Monetary Fund, Honorary Governor, Banque de France, and former President, European Bank for Reconstruction and Development

The present coronavirus crisis is shedding light on some of the consequences of monetary policy as it has been operated over the last decades.

As always, financial crises and instability are caused by excessive debt: global indebtedness has increased by more than 40 percent since 2008. And such a debt explosion had been propelled by easy monetary policy. High leverage was becoming problematic and very risky before the coronavirus broke out. Defaults had started, especially in the high-yield and BBB corporate sectors.

Because of quantitative easing, investors have accumulated huge long-duration interest risk without appropriate pricing. In the eye of asset holders, the only way to avoid a collapse of market instruments would be to continue and intensify quantitative easing.

But the dangers of a systemically accommodative stance with long-running negative real interest rates are well known: they weaken the financial system, create asset bubbles, and blur risk differentiation. And, contrary to expectations, they do not foster productive investment, but encourage the hoarding of the most liquid forms of savings.

One reason for this excessively accommodative policy concerns the enigma of the 2 percent inflation target (a little less than 2 percent but close, says the European Central Bank). This reference to 2 percent is incomprehensible and is, in my view, an intellectual mistake given the price-dampening effects of structural factors such as aging populations, technological changes, globalization, and the evolution of labor market behavior. The equilibrium interest rate, avoiding excessive inflation as well as deflation, is closer to 1 percent than 2 percent. And a 1 percent or 1.5 percent rate is not a problem, rather a sign of stability.

Yet central banks have been meticulously anchoring their monetary policy to 2 percent, an unattainable objective. This has entailed an unnecessary expansion of money creation and a huge debt overhang.

Such a monetary stance embodies self-inflicted pessimism. Betting on an unattainable goal brings a psychological cost. Although central banks cannot reach the arbitrary inflation target, they have come to believe they must create enough fiat money to somewhat "force up" prices.

These ideas fix in the public mind the notion that interest rates will remain negative for a very long period, maybe even several decades. This, in turn, depresses public opinion that comes to believe that central banks have no hope for the future and therefore that it is best to keep away from investing.

With the huge expansion of quantitative easing associated to the pandemic crisis, it is important to reflect on this issue and avoid the pitfalls of unnecessary and harmful high inflation targets.

DAVID G. BLANCHFLOWER

Bruce V. Rauner Professor of Economics, Dartmouth College, and former member, Monetary Policy Committee, Bank of England

In 2008, the world was hit by a financial shock not dissimilar to the Great Crash of 1929. Both started in the Florida housing market and spread. Economist John Maynard Keynes in 1930 warned what was coming:

For it is a possibility that the duration of the slump may be much more prolonged than most people are expecting, and much will be changed both in our ideas and in our methods before we emerge. Not, of course, the duration of the acute phase of the slump, but that of the long, dragging conditions of semi-slump, or at least sub-normal prosperity, which may be expected to succeed the acute phase.

The Great Depression that followed only ended with war. Unemployment in the United States peaked at 25 percent in 1933, and in the United Kingdom was just under 16 percent. During the Great Recession, the unemployment rate hit 10 percent in the United States and 8 percent in the United Kingdom, and the authorities threw the kitchen sink at it, but they were late to the case. The United States went into recession in December 2007 and the rest of the world in April 2008, but nothing much happened in terms of solving the problem until after the failure of Lehman Brothers in September 2008. By then it was too late.

It was hardly surprising that after such a late response by governments and central banks, subsequent growth was slow. Economists missed the big one...