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US could face a permanent slump, warns economist

Not only is long-term economic stagnation possible, but current conditions in the United States could lead to this nightmare scenario. That's the shocking conclusion presented by Brown University economists Gauti Eggertsson and Neil Mehrotra, whose recent paper, "A Model of Secular Stagnation," explains how secular stagnation could come about.

This flies in the face of the popular theory that long-term economic stagnation is not possible. After all, economic agents are expected to adjust to whatever the current economic conditions are, and once they do, the framework for growth should be laid anew.

But by adjusting economic models to allow for the fact that different groups have different needs, the two economists bring a new truth to light.

"In models in which there is some heterogeneity in borrowing and lending, it remains the case that there is a representative saver whose discount factor pins down a positive steady interest rate. But moving away from a representative saver framework to one in which people transition from being borrowers to becoming savers over time due to lifecycle dynamics will have a major effect on the steady state interest rate and can open up the possibility of a secular stagnation," Eggertsson and Mehrotra write.

Using complex models, the paper goes on to show why a "deleveraging shock," a "drop in population growth," or "an increase in income inequality" could all increase savings. And with a short-term nominal interest rate permanently at zero, the central bank will be "unable to generate a sufficient monetary stimulus because the nominal interest rate cannot be negative." Instead, the result is a "permanent drop in output."

Of course, these factors might not sound unfamiliar to close watchers of the U.S. economy.

"It's not a baseline scenario, but I think people should at least be starting to consider the possibility that this could go on for a while," Eggertsson told CNBC.com. That could "lead us to be a little bit less optimistic than people have been about renormalization coming in the next year or two."

So what could get an economy out of an environment of secular stagnation?

Eggertsson, who appeared on Thursday's episode of "Futures Now," says an economy's central bank and government both have big roles to play. An aggressive inflation target is one solution to the type of stagnation described. And another is an aggressive, and potentially permanent (if the shock is permanent) increase in government spending.

—By CNBC's Alex Rosenberg.

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