How lessons from the past 40 years could show us the way out of the coronavirus recession

Were you born in the past 40 years?

Chances are you were — more than half of Australia’s population was.

If so, you’ve grown up in a world in which huge economic trends have been grinding away, influencing politics dramatically, which may make it difficult to escape this recession with the usual monetary and fiscal policies.

Let me explain.

Since the 1980s, politicians in advanced economies have pursued a policy framework that has failed large segments of their populations.

This applies to Australia, Canada, Finland, France, Germany, Italy, Japan, New Zealand, Norway, Portugal, Spain, Sweden, the United States, and the United Kingdom.

Over the past 40 years, for this group of countries, the average rate of economic growth has been slowing, investment to GDP ratios have fallen, business productivity has declined, and inflation has slowed noticeably, while the average real interest rate has dropped from 6 per cent to less than zero.

At the same time, household debt and government debt has exploded.

It has underwritten a huge transfer of wealth up the income distribution to the top 1 per cent.

The global financial crisis then amplified these trends, prompting some economists to ask if the global economy has been suffering “secular stagnation” in the past decade.

The word “secular” means long-term, in this context. “Stagnation” refers to an economy with little or no economic growth.

This conversation started in 2013 when Larry Summers, a former secretary of the US Treasury, wondered publicly why advanced economies had been struggling to grow since the GFC, and why inflation was so low, when interest rates were nearing zero and the world was awash in savings.

His question inspired burgeoning research on the topic.

And this year, a fascinating new paper from the field suggested two culprits were to blame for the phenomenon.

It said rising income inequality, and the liberalisation of the financial sector — both of which originated in the 1980s — had pulled those 14 advanced economies [listed above] into their current low-growth, low-interest rate, high-debt environment.

The paper was called Indebted Demand.

It was written by economics professors Atif Mian (from Princeton University), Ludwig Straub (Harvard University), and Amir Sufi (University of Chicago).

It could have implications for our current attempt to pull ourselves out of the coronavirus recession.

In a nutshell, the paper suggested the bottom 90 per cent of households in those 14 countries, and governments, had become so indebted in the past 40 years it had weighed on aggregate (total) demand.

At the same time, there has been a huge accumulation of income and wealth among the top 1 per cent, and since the super-rich have a greater propensity to save, interest rates have been falling.

Strikingly, the paper also warned popular expansionary policies — such as deficit spending and accommodative monetary policy — may make this current recession worse in the long run.

Why? Because when economies are already stuck in a low-growth, low-interest rate, high-debt “trap”, traditional methods of dealing with recessions can exacerbate the problem.