The elephant in the room of secular stagnation
Secular stagnation involves the idea that Central bank interest rates will be at the zero lower bound (ZLB) for a long… long… time.
And they will be because of falling labor share around the world. Yet, other economists are not even including labor share as a factor. Paul Krugman and Simon Wren-Lewis for examples. Labor share is like the elephant in the room of secular stagnation that no one is seeing. Yet, labor share has fallen from Japan, to the US, to Germany and beyond. Of course China is the King of low labor share.
Falling labor share of national income is keeping the Central bank’s interest rate at the 0% (ZLB). How? The utilization of labor and capital are both constrained to lower levels by insufficient effective demand. The CB rate then goes lower in a vain attempt to raise them back up, but they won’t go back up because low labor share is constraining them. The CBs are fighting a losing battle. Labor share has not just fallen, it has actually anchored into a new lower normal after the 2001 and 2008 recessions.
There is pressure on countries to continue pushing down labor share in order to increase national savings in an attempt to raise exports. Lowering labor share so broadly is bringing down the global economy, and more specifically the workable range of the Central bank rates.
My view to resuscitate the CB rates is to either raise labor share, or shift the Central bank policy to lower expectations for the utilization of labor and capital. If the CBs acknowledge the constraining effect of low labor share on the utilization of labor and capital, they would realize their hopes for success with the ZLB are futile. They would realize that the costs outweigh the benefits of the ZLB since there is not as much spare capacity as they think.
Paul Krugman makes this case that a low interest rate is needed because the spare capacity is so great. He says the potential benefits outweigh the costs from the ZLB. However, once you realize that low labor share has lowered the available capacity, then you realize that his reasoning will ultimately fail. The costs will outweigh the benefits in the end. Look at Latin American countries. The utilization of labor and capital is much lower in Latin America, but the rates from their central banks can go from 3% to 8%. Even with such low utilization rates, which would warrant a permanent ZLB in the US, the Latin American countries know the limits of their labor and capital. Their CBs set rates appropriately. In the US, economists do not know yet that the utilization of labor and capital has shifted to a lower range.
Central banks must fit their rate policy to the new lower range of labor and capital utilization. By surrendering to this sub-optimal truth, CBs would be obliged to raise their rates. The new sub-optimal reality would start to function correctly with less financial risk, albeit with more marginalized workers. Then attempts can be made to restore the former reality of a higher labor share. But that would require coordination on a global scale.
As for now, CBs are drowning in the delusions that they are still in the former reality.
The truth is hard to accept, especially this truth of secular stagnation.
Lambert, Edward. Monetary Policy of Effective Demand. Effective Demand blog. 5/18/2013.
Lambert, Edward. Equation for the z coefficient of monetary policy. Effective Demand blog. 5/28/2013
Lambert, Edward. Monetary Policy, take some air out of the tires. Effective Demand blog. 6/5/2013.
Let me posit a partial reason that is sometimes discussed for stagnation: low population growth. The best example of this is Japan which has negative population growth. (i.e. population is decreasing). As a population ages less is consumed.
There is another problem. It is real wage stagnation in an age of massive productivity increases. So, even at fair firms like BMW we see that production, revenue, and especially profits massively outgrow wage increases. But the system just can’t function if more and more cars are produced with largely the same amount of workers, who get paid about the same as 10 years ago in real terms.