Here Comes Another Great Moderation: Slow, Steady Growth

(Illustration by Carl Godfrey)

About the author: Marc Chandler is chief market strategist at Bannockburn Global Forex, a division of First Financial Bank.

Economists have for years delivered epitaphs of the Great Moderation, the period from mid-1980s to 2007 when growth was slow and steady, inflation low, and interest rates trended down. Ben Bernanke, when he was chair of the Federal Reserve, famously framed the era as the product of better policy, a more benign environment, and sheer luck. Catherine Mann, an American economist at the Bank of England, warns that today’s world is too volatile for those economic conditions to return.

Both overlook the structural forces that could bring moderation back. Those forces are becoming more, not less, entrenched.

The first is surplus capital. Global savings have been swelling for decades, buoyed by trade surpluses in Asia and northern Europe, growing corporate cash piles, and states accumulating resources in sovereign wealth funds rather than reserves. There is now more capital than productive outlets are able to absorb at acceptable returns. Bernanke identified a “global savings glut” nearly 20 years ago. What he didn’t anticipate is how persistent and generalized that glut would be.

Capital abundance pushes down its own price—the real rate of interest. The Swiss National Bank key policy rate is set at zero, and the swaps market anticipates a push into negative territory later this year. The Bank of Japan’s policy rate of 0.5% is deeply negative when adjusted for inflation, as are its long-term bond yields. At 2%, the European Central Bank’s policy rate is near zero after accounting for inflation. Recent research by the New York Fed concluded that there is a significant possibility in the coming years of a return to a near-zero Fed-secured overnight funding rate. The bank’s president, John Williams, opined this week that the real neutral rate hasn’t changed in recent years.

The second force is demographics. A dearth of births constrains labor force growth. In many countries, fertility rates have slipped below replacement. Fewer young workers means slower potential output growth, and with it, lower natural interest rates. It also suggests that the struggle to sustain aggregate demand will persist.

These forces—surplus savings and sinking demographics—act as long-term anchors. They don’t eliminate shocks: Pandemics, wars, and energy price spikes will still hit. But economies will drift back to the structural norm once disruptions are absorbed.

Service industries now dominate the economy. They are less cyclical than agriculture and manufacturing. Relatively little of the economy is tied to inventory cycles, global shipping disruptions, and harvests. The result is a longer, flatter business cycle—slower to overheat, slower to collapse.

Put these pieces together and the outlines of another Great Moderation gradually come into view: A period of low inflation, low growth, and low interest rates lies ahead. Policymakers may resist the label, but the conditions underlying it are undeniable.

This isn’t to say it will be an equilibrium in the sense of a stable, self-sustaining system. It will remain hard for both capital and labor to reproduce themselves. Productivity growth will still be needed to keep living standards rising, and investment opportunities will remain scarce enough to keep yields down. But the pull of savings and demographics is strong.

Larry Summers has warned of “secular stagnation,” in which chronically insufficient demand keeps economies below their potential and dependent on asset bubbles or fiscal stimulus for growth. The next Great Moderation won’t be quite that; the volatility of growth and inflation will be muted, without violent boom/bust patterns.

Geopolitical shocks and climate disruptions will still jolt the system. But advanced capitalist economies have shown repeatedly that such shocks are transitory relative to structural undercurrents. Pandemic stimulus faded, supply-chain snarls eased, energy markets adjusted. The deeper patterns remained: Too much capital chasing too few high-return opportunities and too few people entering the labor force to drive sustained demand or inflation.

The Great Moderation was never perfectly calm. The dot-com bust and the 2001 recession happened right in the middle of it. But the amplitude of cycles was mostly smaller. The inflationary surges of the 1970s became a distant memory. Critics will argue that we are in an age of fragmentation, with deglobalization and geopolitical rivalry pushing costs up. They may be right in the short term. But fragmentation has limits. The capital seeking safety and return must go somewhere.

Bernanke and Mann envisioned different futures, but neither squarely addressed the role of surplus savings in shaping the macro landscape. When combined with sobering demographics, it is hard to escape the conclusion that advanced economies are structurally tilted toward a second Great Moderation. Slow growth—not stagnation—will be more dependent on productivity than labor force growth. Businesses and investors will struggle to find sufficiently profitable outlets for their investment, keeping inflation and interest rates low.

In such a world, per capita GDP, not headline GDP, becomes the key metric of success. Japan has shown it is possible to get richer, even with a shrinking population. For investors and policymakers alike, that may be the most important lesson of the next decade.

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