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The Normalization Delusion

The Normalization Delusion

LONDON – There is a psychological bias to believe that exceptional events eventually give way to a return to “normal times.” Many economic commentators now focus on prospects for “exit” from nearly a decade of ultra-loose monetary policy, with central banks reducing their balance sheets to “normal” levels and gradually raising interest rates. But we are far from a return to pre-crisis normality.

After years of falling global growth forecasts, 2017 has witnessed a significant uptick, and there is a good case for slight interest-rate increases. But the advanced economies still face too-low inflation and only moderate growth, and recovery will continue to rely on fiscal stimulus, underpinned if necessary by debt monetization.

Since 2007, per capita GDP in the eurozone, Japan, and the United States are up just 0.3%, 4.4%, and 5%, respectively. Part of the slowdown from pre-crisis norms of 1.5-2% annual growth may reflect supply-side factors; productivity growth may face structural headwinds.

But part of the problem is deficient nominal demand. Despite central banks’ massive stimulus efforts, nominal GDP from 2007-16 grew 2.8% per year in the US, 1.5% in the eurozone, and just 0.2% in Japan, making it impossible to achieve moderate growth plus annual inflation in line with 2% targets. US inflation has now undershot the Federal Reserve’s target for five years, and has trended down over the last five months.

Faced with this abnormality, some economists search for one-off factors, such as “free” minutes for US cell phones, that are temporarily depressing US inflation measures. But mobile-phone pricing in the US cannot explain why Japan’s core inflation is stuck around zero. Common long-term factors must explain this global phenomenon.

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