The Stamp Memorial Lecture 2017 hosted by the Department of Economics and the

Centre for Macroeconomics

The State of Advanced Economies: forces, interactions

and uncertainties

Professor Olivier Blanchard Fred Bergsten Senior Fellow, Peterson Institute, Washington

Robert M Solow Professor of Economics emeritus, MIT

Hashtag for Twitter users: #LSEStamp

Professor Silvana Tenreyro Chair, LSE

State of the Advanced Economies:

Forces, Interactions, Uncertainties

Stamp Lecture, LSE

Olivier Blanchard

Peterson Institute for International Economics | 1750 Massachusetts Ave., NW | Washington, DC 20036 3/27/2017 2

Three main forces at work

1. Legacies from the financial/euro crises. Fading, but unevenly across countries 2. Lower current and prospective productivity growth. Important even in the short run. Demand effects fading. 3. Political uncertainty, and shades of populism. Translating into macro uncertainty?

• Interactions: A better but still mediocre baseline

• Uncertainties. A highly uncertain baseline.

1. Legacies from the (acute phases of the) financial and euro crises

• High private debt (largely from before the crisis)

• High public debt (largely from during the crisis )

• Why high debt matters. Asymmetry debtors/creditors

• Initial adjustment: Fiscal consolidation, deleverage, private saving

• Dominated 2010-2014. Largely over.

• After the initial adjustment

• Interest and growth sensitivity. Still very relevant

• Countries most exposed

• Japan: At potential, but with extremely high debt

• Euro periphery. Far from potential, with high debt

60.00

80.00

100.00

120.00

140.00

160.00

180.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Household debt level (% disposable income )

USA Euro area Spain, Portugal and Italy United KingdomSource: OECD

20

40

60

80

100

120

140

160

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Government debt level (% GDP)

USA Euro area Spain, Portugal and Italy United KingdomSource: OECD

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Change of general government structural balance (Percent of potential GDP)

Advanced economies United States Euro area United Kingdom

Source: IMF WEO, October 2016

Changes in credit availability

2. Lower productivity growth

Very low during the crisis. Not very surprising.

But also very low since then, despite recovery: Unusual.

True for nearly all advanced economies *

Magnitude of revisions in potential growth: Substantial

CBO US estimates. * More than 1% decline since 2002

About 0.5% decline since 2012.

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Growth of GDP per hour worked, constant prices 5-year moving averages

Broad advanced country average (unweighted) France Germany Japan UK US

1.90

2.10

2.30

2.50

2.70

2.90

3.10

3.30

3.50

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Long run potential growth (CBO forecast)

Source: Congressional Budget Office

Could it be measurement error?

• IT sector badly measured, especially software. But Still small sector. Also, more IT produced abroad. No effect on US productivity • A lot of measurement problems in intermediate goods. Does not matter for overall productivity. • A lot of improvement in quality of leisure. Not part of market economy. Not measured in GDP • But what about health care, transportation?

• Probably understates the level, but unlikely to explain the decrease since

the crisis. • What if growth were in fact higher? Perceptions matter. Would

populism be as successful?

What about future productivity growth?

• Innovation continues apace. (although becoming more expensive)

• At the frontier, productivity growth comes in bursts. 1995-2005.

• Low correlation from decade to decade

The meta discussion:

• The end of major discoveries: Gordon, *

• The era of technological breakthroughs

• Robots, and the end of work. Perceptions and reality.

Why does all this matter today? Anticipation effects:

• Weak demand in anticipation of a mediocre future

• Explains why we have had weak demand growth despite zero rates

• If no further bad news, demand should/will recover partly.

3. Inequality, populism, and political risks.

Political surprises. Brexit, US elections, shifts towards populism,

Sources: Inequality? In part, but a complicated story

United States versus France. * *

Implications?

• The Trump incarnation. Non standard. Pro-business, checks and balances

• The risk of more traditional populism elsewhere?

The evolution of relative wages: United States versus France

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Some high school High school diploma College degree Advanced degree

US: Evolution of Relative Wages, by Education Level, 1973-2012

1973=1.0

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Some high school High school diploma College degree Advanced degree

France: Evolution of Relative Wages, by Education Level, 1990-2012

1990=1.0

Evolution of relative wages in the UK

Percentage hourly pay gap to employees with GCSE or equivalent level of education, age 22 to 64

Source: Office for National Statistics, Earnings by Qualification

Macro implications of Trump policies. Uncertainty

Fiscal policy. Administration versus Congress Infrastructure, tax cuts versus deficit hawks Corporate tax cuts and some deregulation Best guess: Some increase in deficits Monetary policy. Two levels of uncertainty. Reaction function of the Fed to deficits? Governance at the Fed? Hawks versus doves Trade policy. Trade wars or symbolic wars? Trade war tools. Old: Tariffs New: Dislocation of global supply chains Big issue: Effect of uncertainty per se? *

0

10

20

30

40

50

60

70

0

50

100

150

200

250

300

350

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Economic Policy and Financial uncertainties

News_Based_Policy_Uncert_Index Global EPU Index with PPP-adjusted GDP Weights VIX

Sources: Policyuncertainty.com, Haver analytics

Putting it together. Baseline

• Slow fading of financial crisis legacies

Debt ratios will decrease very slowly

But they are not constraining demand

• If no further downward revisions of medium term growth

End of short term demand adjustment

• Trump fiscal expansion, cum higher uncertainty.

• Medium term: Remaining low potential growth.

All imply:

Stronger demand growth in advanced economies in 2017-2018

Increase in interest rates. More so in US

-4

-2

0

2

4

6

8

10

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Growth rates (current and IMF forecast)

World Advanced economies Emerging market and developing economies

Source: IMF WEO, October 2016

Putting it together. (Two) Risks.

In a high debt (D) environment, what is crucial is the joint movements in

growth (g), and the real interest rate (r).

The risk of stronger demand, and higher interest rates.

Interaction with high public debt

Danger in Euro periphery

Danger in Japan

The risk of stronger productivity growth

Likely to come with interest rates also.

If g, r move together, roughly neutral for debt ratios

The Stamp Memorial Lecture 2017 hosted by the Department of Economics and the

Centre for Macroeconomics

The State of Advanced Economies: forces, interactions

and uncertainties

Professor Olivier Blanchard Fred Bergsten Senior Fellow, Peterson Institute, Washington

Robert M Solow Professor of Economics emeritus, MIT

Hashtag for Twitter users: #LSEStamp

Professor Silvana Tenreyro Chair, LSE