Zero interest rates and slow growth - Keynes got there before us!

Ten years ago, the financial crisis began to grip the Western economies. During the course of 2007, GDP growth slowed markedly everywhere. By the end of 2008, output was in free fall. A key theme in economic commentary is the sluggishness of the subsequent recovery of the developed economies.

The picture is not quite as bad as it is usually painted.  True, last week the Office for National Statistics announced a dip in UK growth in the first quarter of this year.  But from 2009, the trough of the recession, to 2016, GDP growth averaged 2.0 per cent a year.  Not exactly a stellar performance.  But from 1973, the year prior to the major oil price shock, to 2007, the British economy expanded by just 2.3 per cent a year on average.  The contrast between the two periods in the US is slightly greater.  From 1973 to 2007, growth averaged 3.0 per cent a year, and since 2009 it has been 2.1 per cent.

There is a very stark contrast with the experience of the 1930s, the last time there was a global financial crisis.  This time is different, things have only got better.  The recovery may be slower than desirable, but it has been much more widespread than in the years following the Great Depression of the 1930s.

A decisive indicator is the length of time it took not just for growth to resume, but for the previous peak level of GDP to be regained.  So in the UK, for example, the economy started to grow again in 2010.  But it was not until 2013 that there had been enough growth for the economy to get back to its 2007 size.

Looking at a group of 18 developed economies, which includes all the main and medium sized ones, GDP had regained its previous peak within 3 years in no fewer than 8 of them.  By 2016, everyone in the group except Finland, Italy and Spain had a GDP which exceeded its previous peak.

Three years after output began to fall in 1930, not a single economy had managed to regain its 1929 level of output.  Even by 1938, output was below its 1929 level in Austria, Canada, France, the Netherlands, Switzerland and Spain.

Perhaps Keynes’ most powerful insight was why the slump was so prolonged.  He developed the concept of “animal spirits”, which are not a mathematically based prediction of the future, but the sentiment of the narratives which companies form about the future.  He wrote: “the essence of the situation is to be found in the collapse of animal spirits.... this may be so complete that no practicable reduction in the rate of interest will be enough.”

Zero interest rates and low growth!  Keynes got there before us. 

Still, capitalism has performed much better in the aftermath of the financial crisis of the late 2000s than it did in the crisis of the early 1930s.  Animal spirits may not be buoyant, but they are in much better shape than in the 1930s.