A Tale of Two Theories

In the eurozone, growth in the latest quarter was underwhelming. Japan has returned to negative territory. Brazil and Russia are in recession. World trade has stalled. And China’s economic slowdown and market turmoil this summer have created further uncertainty.

True, there are bright spots: India, Spain, and the United Kingdom are beating expectations. The United States’ recovery is solid. Africa is doing well. But, overall, it is hard to deny that the global economy lacks momentum.

This is partly because trees cannot grow forever: China’s economy could not continue to get 10% bigger every year. And in part, it is because growth is not unconditionally desirable: Citizens may be better off with a little less of it, and more clean air.

But many countries are still poor enough to be endowed with strong growth potential, and many others, though rich, have not yet recovered from the global financial crisis. So there must be something else holding growth back.

There are essentially two competing explanations. The first, the Secular Stagnation Hypothesis, has been proposed by Larry Summers. Its key premise is that the equilibrium interest rate at which demand would balance supply is currently below the actual interest rate.

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