Today, I want to explore those deeper questions and what they mean for policy. But before raising the pessimists’ challenge, let me first keep with recent practice by setting out this year’s reasons for optimism. Grounds for optimism The news from the UK is positive. Inflation has fallen, from more than 5% in 2011 to 2.2% now, jobs are being created at a rate of 60,000 per month, and growth is – for the moment – the strongest in the advanced world.1 This recovery is relatively recent, having started in earnest during the second quarter of the year. Its timing and pace caught most unawares. Certainly, the cumulative run of economic surprises has dwarfed those of the other major advanced economies (Chart 2). With the wisdom of hindsight, there were three main drivers of the recovery: a marked reduction in extreme uncertainty (Chart 3); significant progress on repairing the core of the financial system, with risk-weighted capital ratios doubling in recent years; and a marked improvement in household balance sheets, where debt to income ratios have fallen by about 30 percentage points. Together, improved access to finance and raised expectations of future prospects led to a reduction in precautionary savings by households, a modest recovery in consumer spending, a revival in housing investment from very low levels and an increase in business confidence to a 15-year high.
The strength of the UK recovery and the fall in its unemployment rate suggest that the equilibrium real interest rate is now rising gradually back towards zero. The Ghost of Christmas Past should not be forgotten. A recovery may be gaining pace but our economies are a long way from normal. Leverage is still high and weak demand for advanced economy exports could persist for some time. The Ghost of Christmas Yet to Come suggests that it is unlikely that equilibrium interest rates will return to historically normal levels any time soon. This prospect puts a premium on macro-prudential policies and financial reforms to manage the associated risks without abandoning the need to keep interest rates in line with the equilibrium level. So while it is unsurprising that the ideas behind secular stagnation are being revived, it would be a mistake to rush to a more extreme macroeconomic response. There is a long history of pessimism in economics, from Thomas Malthus through Alvin Hansen to Robert Gordon. Such worries have proven misplaced in the past and scepticism is warranted now. Don’t forget that the US economy is more than 13 times larger than when Hansen first formulated his ideas. Similar performance must again be possible. Central banks are playing a catalytic role to help deliver it but their contribution will ultimately be limited. The most important drivers of long term prosperity will be measures taken by others to increase the growth of supply, particularly those that reinforce an open, global economy.