Handling the long period of weak economic growth in the world economy: limitations and solutions.

In my last blog post , I discussed the arrival of the "new mediocre" in the world economy. In this blogpost I am going to venture into some solutions and challenges, which stand in the way of managing the new mediocre.

Pre-empting the new mediocre is going to require a variety of measures: loose monetary policies, fiscal support, and structural reforms. Lets discuss them one by one.

 Monetary policies

Following the global economic crisis of 2007, the interest rates were cut in the U.S. and elsewhere. After interest rates came close to zero and their effect on aggregate demand declined, U.S resorted to quantitative easing(QE)  in 2008 and ECB in 2009. This meant the central banks buying long-term securities and it was intended to lower the long term interest rate.

Now, we have entered a brand new era, with central banks in EU and Japan moving towards negative interest rates. This means charging depositors to keep cash in banks and paying borrowers for taking loans.

But, since depositors have little incentive to deposit money so negative rates end up passed on to borrowers and not to depositors. This diminishes the profitability of banks. Moreover, negative interest rates may lead to a surge in productive investment but to asset bubbles and another financial crisis.

Fiscal support

Many of the economists now believe that monetary policy has run it's course and for couse correction we need fiscal support. This fiscal support has to be in the form of increased government spending on infrastructure or tax incentives to promote a higher minimum wage.Governments are, however, unwilling or unable to boost spending. Main causes for this may be the high cost of social security and debt obligations of U.S. Countries like Germany which might have some leeway for spending believe that there is only so much that it can do to help others in the Euro zone. Fears that minimum wages if raised will lead to inflation which can go out of control and the wages cannot be lowered once lowered. 

Structural reforms

It includes things like cutting unemployment benefits, making it easier to hire and fire, reducing barriers to entry, etc. But many of these measures are unpopular due to the electoral ramifications . Also, such measures yield benefits only over a long period.

Two viewpoints have emerged. One, that the growth potential of the world is limited. And, that we lack the instruments to step up the growth rate without creating serious risks. Therefore, in dealing with the new mediocre we don't have to aim for the sky. Just focus on minimising the vulnerabilities  in the economy, such as those in the financial sector or on the external account.