“Drive slowly, grow longer”

Maybe Janet Yellen set it off with her comment in December “The global economy is doing well. We’re in a synchronized expansion. This is the first time in many years that we’ve seen this.”

It was picked up in Davos:

DAVOS, Switzerland—The world is enjoying its broadest, strongest growth in years, and everyone has an explanation, from the U.S. tax cut to the recovery in oil prices.

Let´s check.

World industrial production may be a good proxy for overall world economic activity. The chart indicates that it is not only the advanced economies such as the US, EZ or UK that are mired in a long depression, the world economy appears to be there also.

An incipient recovery was cut short in 2011. Some of that reflects the ECB tightening under Trichet, which plunged the EZ into a double dip recession.

The chart above shows that the level of world industrial production remains depressed, but there is growth.

The chart below shows that the incipient recovery was cut short when growth fell drastically in 2011. From that point, growth has fluctuated between 1% and 4%. The fact that it has remained near 4% for some months brings forth these “exalted” comments on “synchronized growth.”

Growth, even at 4%, has been low. Instead of “rejoicing” about that lackluster behavior they call “broad and strong”, policymakers should be trying to understand why many economies (including the overall world economy) have never recovered, remaining depressed.

That is certainly not the usual outcome. Using the US as example, there are several instances where the economy experienced deep recessions and even depressions, but recovered. The recovery from the Great Depression, for example, was negatively impacted by monetary policy mistakes in 1937.

One reason might be that the “modern economy” is “constrained” by unknowns. Things like “natural interest rates”, “natural rate of unemployment” and “potential output”. There is also the inflation target barrier.

The mixing of all these ingredients may have led the Fed (and other central banks) to “drive slowly”, afraid to have to use the brake more forcefully down the road. As Kocherlakota put it:

This systematic avoidance of big interest-rate increases might sound like a dovish, growth-friendly regime. In fact, it’s the opposite. To understand why, imagine driving a car in which, for some reason, you’ve decided to never use the brakes. Naturally, you’ll speed up more if you happen to hit a downhill patch. To compensate for that risk, you’ll drive more slowly all the time. It’ll take you longer — maybe much longer — to get where you’re going.

This is exactly the Fed’s situation. It has decided that it will never hit the brakes by raising rates quickly. So it has to apply stimulus very cautiously, to be sure that the economy never gets close to overheating. The result is that inflation has been below target and economic output has been below potential for nearly all of the past 23 years.

In a little over one year, this expansion will beat the record set by the 1990s expansion. Bernanke, Yellen and Powell will be hailed as “heroes”. The new motto will be “drive slowly, grow longer!”


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