Blog Post

How can Europe avoid secular stagnation?

Larry Summers crystallized an important question in a recent speech: Has the world economy entered a period of “secular stagnation”? The slow recovery in the United States since the financial crisis is his starting point and he argues that secular stagnation could also retrospectively explain features of previous decades, such as low inflation.

By: Date: November 25, 2014 Topic: Global economy and trade

Larry Summers crystallized an important question in a recent speech: Has the world economy entered a period of “secular stagnation”? The slow recovery in the United States since the financial crisis is his starting point and he argues that secular stagnation could also retrospectively explain features of previous decades, such as low inflation. Professor Summers had picked up an old term first coined by Alvin Hanson (1939), in his Presidential Address of the American Economic Association in 1938. Back then, Hanson focussed on the importance of (public) investment expenditure to achieve full employment. His argument was that for such investment to happen, the economy needs new inventions, the discovery of new territory and new resources, and finally, population growth.

Summers’ argument is centered on the fact that inflation rates have been falling for the past two decades and have often been lower than expected. Is a permanent fall in the equilibrium real interest rates needed to achieve full employment? Olivier Blanchard (2013) argued that it is advisable to have higher inflation rates in normal times as this makes it possible to drive down nominal interest rates more substantially so that real interest rates fall even further in crisis times. Krugman (2013) goes one step further, and even argues that the new normal may be a permanent liquidity trap, so it would therefore not be advisable to have low inflation rates in the eurozone2 and the inflation rate should be increased.

So how can we summarize the situation today in the eurozone and what policy measures can be envisaged to improve the situation? I would identify three fundamental issues facing the eurozone currently.

The first issue is a lack of aggregate demand and a corresponding fall in inflation rates. The economic recovery in the eurozone has been weak and recent data show that it may slide back into a full recession again. Correspondingly, unemployment remains very high, in particular for the young. In addition, inflation rates have been falling since late 2011, and forward-looking indicators now suggest that inflation expectations have become disanchored from the close-but-below 2 percent goal.

The second important issue is the combination of significant divergences in unit labor cost with the build-up of large levels of debt, in both the private and public sector in the eurozone periphery. The gap in unit labor costs that has opened between Italy and Germany since the beginning of the euro amounts to more than 20 percent, while the gap between France and Germany is similarly around 20 percent. At the same time, debt to GPD ratios have increased prior to the crisis mostly in the private sector while since the beginning of the crisis, high deficits have added to a substantial increase in public debt to GDP ratios, for example by more than 60 percent of GDP in Spain.

The third problem is the remaining uncertainty around the state of the banking system as well as doubts about the profitability of the system. While the European Central Bank’s (ECB) asset quality review (AQR) and stress test should remove uncertainty, the assessment by the IMF is quite clear that more restructuring may be pending.3 Non-performing loans remain high in a number of countries.

It is against these three central issues that any policy response for the eurozone has to be formulated.

Partial proposals aimed at addressing only some of the above problems are unlikely to deliver results that will satisfactorily create stable and robust growth and new employment opportunities. The solution must be found in the current context of a monetary union operating without a fiscal union, and thus there are limits on what monetary policy is allowed to do. Dealing with the problems of the eurozone therefore goes beyond the risk of secular stagnation. In fact, some of the fundamental issues may not be solvable without further steps towards fiscal union.

Three central policy measures to deal with stagnation in the euro area

First, policies need to be designed to address the demand shortage. U.S.-based Keynesians typically suggest that eurozone periphery countries should increase their deficits in response to the recession. However, this argument fails to acknowledge that debt levels have already increased substantially due to high deficits and that in a monetary union, sub-federal debt is inherently less stable. In fact, the eurozone has already used substantial fiscal resources to lessen the impact of the shock. Unless one is willing to accept the ECB as an unconditional lender of last resort, a policy recommendation to increase periphery deficits could quickly lead to renewed market stress with very harmful consequences for financial stability, which would in turn deteriorate the economic situation substantially. While one can argue that the ECB should automatically act as a lender of last resort to governments and buy governments bonds without conditions even in countries under stress, the legality of this arrangement is heatedly debated. While I would argue that the Outright Monetary Transactions (OMT) program is economically justified and legal, it certainly cannot be misread as an automatic policy to buy debt under all conditions. In fact, only a clear political consensus on the sustainability of debt in the context of a European Stability Mechanism (ESM) program would allow the activation of bond purchases from distressed countries.

4 Claeys et al (2014)

Consequently, the best way to increase eurozone demand will be by a combination of more fiscal measures in countries with strong fiscal positions and a build-up of a eurozone fiscal capacity, together with more aggressive monetary policy. Germany in particular could use its fiscal space to increase borrowing to fund public investment as well as reduce taxes on low-income households. A eurozone fiscal capacity could be built up by using existing instruments, such as the European Investment Bank (EIB), much more forcefully, for example by increasing the EIB’s leverage. Such European funds could be used to fund European investment projects as well as to support national budgets where public investment has been cut substantially recently. Monetary policy could be more aggressive by buying more bonds issued by the EIB, asset-backed securities, covered bonds as well as corporate bonds.4

5 Ruscher and Wolff (2012)


Second, bold measures are needed to address the substantial unit labor cost divergence and substantial debt overhang. The empirical literature is clear that countries with high unit labor costs will find it difficult to attract new and productive industry, especially if their tax levels are high.The debt overhang in the private sector in some periphery countries is holding back new investments and can lead to a negative feedback-loop between corporate debt and a weak banking system, as has been seen in Japan.5 At the same time, it needs to be made clear that unit labor costs require an adjustment in both the deficit and the surplus countries in order to be politically feasible and economically effective. I would therefore advocate for bold structural reforms such as increases in annual working hours and increases in retirement ages to address the unit labor cost problem in the deficit countries. In the surplus countries, reforms that open up professions and lead to the creation of new industries are paramount in order to achieve adjustment. The introduction of minimum wages is a riskier policy measure, but the public sector and its wage-setting can be part of the answer to support rebalancing. To deal with the high private debt levels, restructuring and reorganization in the banking system are important. One should also consider reviewing insolvency regimes and restructuring frameworks for the corporate and household sector, as has recently been argued by the IMF’s legal counsel Sean Hagan.6 Policies such as non-recourse loans for mortgages have greatly helped to reduce the debt overhang in the household sector of the U.S.

Third, the remaining banking sector problems need to be addressed. It is obvious that the ECB needs to be ambitious in its stress tests and AQR. The way the exercise has been designed largely prevents the deleveraging pressure to result in a reduction in lending. Rather, the logic of the exercise should lead to deleveraging through strengthening the capital base, and there is some evidence of such an increase having happened in the euro-zone banking system. An important question is about the right interplay between monetary policies and the ongoing bank restructuring process. Some of the ECB’s recent measures, such as the TLTRO (targeted longer-term refinancing operations) measure may delay some bank restructuring while adding little to ease monetary conditions. It would be useful to reconsider the balance between active management of the balance sheet of the ECB through unconventional measures and the policies directly aimed at supporting liquidity in the banking system.

This overall mix of policies should deliver results in terms of addressing the underlying weaknesses of the eurozone and revitalizing growth. While a lot can be done within the framework of the current institutions, this policy mix also points to the need to upgrade the European policy framework and move towards the creation of a eurozone fiscal capacity.

Some have argued that the eurozone needs a change in its inflation target to overcome the crisis and to be better equipped to deal with secular stagnation. However, I fail to see how an increase in the inflation target can be achieved in normal times without generating significant risks to the economy. One of the important features of the pre-crisis global economy was that inflation rates were falling despite loose monetary policy and arguably overly optimistic asset markets. In fact, more demand generated by monetary policy prior to the crisis would have led to even more substantial distortions in the asset markets and in the real economy. This could have triggered an even more substantial crisis than the one we are seeing currently. Perhaps more important than this rather theoretical consideration of normal times is an assessment of a potential change in the inflation target within the current situation. A change in the inflation target by the ECB from 2 to 4 percent, for example, would undermine the credibility of the ECB in many respects. On the one hand, it would undermine trust in the institution by all those who have relied on the ECB to keep inflation at close but below 2 percent. On the other hand, even now the ECB’s credibility is endangered by the fall of inflation expectations below 2 percent. Market participants fear that the ECB will not be able to push inflation up to the target level with its existing policy instruments. Instead of changing the target, the ECB would therefore be well advised to deliver bolder policies to convince markets that it is serious about achieving its current target.

To summarize, like Hansen, I believe in the importance of the structural factors that actually provide the conditions for new investment opportunities. Fundamentally, we need to know why the equilibrium interest rate has been falling globally and why the global economy has entered “secular stagnation”. Is it global demographics? Is it the lack of good investment opportunities? Certainly, these challenges need to be addressed. Also the eurozone needs to see more substantial structural policy actions to increase its long-term growth potential and to tackle the very substantial divergences between the different member states of the eurozone.


But macroeconomic policies will also have to play a larger role. One of the big problems in the eurozone has been the weakness in public investment in the last few years, in contrast to the U.S., where public investment actually increased. More European level investment in European public goods such as new and better energy and digital networks should also be undertaken. But the EU will also need a boost in domestic investment at the member state level. Monetary policy needs to be bolder and arguably the ECB has the instruments available. Overall, President Draghi’s Jackson Hole speech points the way in the right direction.7 The euro area needs bolder fiscal and structural policies, and the ECB must also play its part.

This article was republished from Brookings’ Think Tank 20.

1 This article is based in part on commentary published by the author on August 19, 2014, titled “Monetary Policy Cannot Solve Secular Stagnation Alone.”


Blanchard, Olivier. 2013. “Monetary Policy Will Never Be the Same.” Voxeu Blog. 27 November 2013. 

Claeys, Darvas, Merler and Wolff. 2014. “Addressing Low Inflation: the ECB’s Shopping List.” Bruegel policy contribution.

Draghi, Mario. 2014. “Unemployment in the Euro Area.” speech at the Annual European Central Bank Symposium. 22 August 2014.

ECB. 2014. ECB press conference.

Hagan, Sean. 2014. “Resolving the Private Sector Debt Overhang in Europe.” Remarks as Panelist at IMF Seminar. 11 October 2014. 

Hansen, Alvin. 1939. Economic Progress and Declining Population Growth. American Economic Review.

IMF. 2014. “Global Financial Stability Report: Risk Taking Liquidity and Shadow Banking: Curbing Excess While Promoting Growth.”

King, Stephen. 2013. “There is No Easy Escape from Secular Stagnation.” FT blog. 25 November 2013. 

Krugman, Paul. 2013a. “Three charts on secular stagnation.” New York Times.

Krugman, Paul. 2013b. “Secular Stagnation in the Euro Area.” New York Times.

Ruscher, Eric and Guntram Wolff. 2012. “Balance Sheet Adjustment: Stylized Facts, Causes and Consequences.” Bruegel Working Paper. 2012 (03).

Summers, Lawrence H. 2013. “Crises Yesterday and Today.” speech at the 14th Jacques Polak Annual Research Conference. November.

Wolff, Guntram. 2014. “Monetary Policy Cannot Solve Secular Stagnation Alone.” commentary 19 August, 2014

2 Krugman (2013b)

3 See the latest IMF (2014), Global Financial Stability Report, “Risk Taking, Liquidity and Shadow Banking: curbing excess while promoting growth”, October 2014

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic

Blog Post

Secular stagnation and the future of economic stabilisation

Larry Summers’ and Łukasz Rachel’s most recent study documents a secular fall in neutral real rates in advanced economies. According to the authors, this fall would be even more marked in the absence of offsetting fiscal policies. Policymaking in a world of permanently low interest rates may be hard to navigate, especially in troubled waters. We review economists’ views on the matter

By: Inês Goncalves Raposo and Bruegel Topic: Macroeconomic policy Date: April 1, 2019
Read article More on this topic

Blog Post

Economy of Intangibles

Economists have been discussing the implications of the rise of the intangible economy in relation to the secular stagnation hypothesis, and looking more generally into the policy implications it has for taxation. We review some recent contributions.

By: Silvia Merler and Bruegel Topic: Banking and capital markets Date: July 16, 2018
Read article More on this topic


Another slow year for the global economy

The factors that dragged down the global economy in 2015 will persist – and in some cases even intensify – in the new year.

By: Ashoka Mody and Bruegel Topic: Global economy and trade Date: January 5, 2016
Read about event

Past Event

Past Event

Secular Stagnation in Europe and Japan

This is the 3rd conference in a series of events jointly organised by Graduate School of Economics, Kobe University and Bruegel

Speakers: Grégory Claeys, Marcia De Wachter, Philipp Hartmann, Juan F. Jimeno, Toshiki Jinushi, Yoichi Matsubayashi, Ryuzo Miyao, Rainer Münz, Xavier Ragot, Paul Swaim, Coen Teulings, Atsuko Ueda, Natacha Valla, Guntram B. Wolff, Masahiko Yoshii and Naoyuki Yoshino Topic: Global economy and trade, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 5, 2015
Read article More on this topic More by this author

Blog Post

Is the economy stationary?

What’s at stake: The question of whether capitalist economies are self-correcting and will eventually revert to mean growth has received renewed interest given the underperformance of most economies six years after the onset of the Great Recessions. While the idea of persistent high unemployment was central to Keynes’ General Theory, it was quickly abandoned by the neoclassical synthesis.

By: Jérémie Cohen-Setton Topic: Macroeconomic policy Date: May 18, 2015
Read article More on this topic More by this author


Why we should not blame the ECB for low returns on German savings

The ECB has lowered its official interest rate several times in the last years and the rate is now at zero. In March of this year, it has in addition started a large sovereign bond purchase programme. Contrary to popular belief, however, the ECB is not the main driver of the decline in interest rates. 

By: Guntram B. Wolff Topic: Macroeconomic policy Date: May 7, 2015
Read article More on this topic More by this author

Blog Post

Secular stagnation and capital flows

What’s at stake: Former Chairman of the Federal Reserve and new blogger Ben Bernanke has generated many discussions this week by challenging the secular stagnation idea. Bernanke argues, in particular, that the stagnationists have failed to properly take into account how capital flows can mitigate or even eliminate the problems generated by secular stagnation at home.

By: Jérémie Cohen-Setton Topic: Macroeconomic policy Date: April 7, 2015
Read article More on this topic

Blog Post

What is behind the reduction of private sector debt? Comparing Spain and the UK

Spain and the United Kingdom are going through a deleveraging process, with their private debt-to-GDP ratios dropping by around 18% in the United Kingdom and 15.5% in Spain from their respective peaks some years ago. However, the mechanics behind the deleveraging process show substantial differences between the two countries.

By: Pia Hüttl and Guntram B. Wolff Topic: Macroeconomic policy Date: December 5, 2014
Read article More on this topic More by this author

Blog Post

The ECB’s balance sheet, if needed

In his press conference on November 6th, ECB President Mario Draghi pledged monetary stimulus, although only “if needed.” These words have won Mr. Draghi many admirers for his determination to move decisively forward. But the actions tell a different story. The “if needed” mantra is only the most recent example of the ECB’s congenital conservatism in dealing with the ever-unfolding crisis. Once again, the ECB is behind the curve even as a debt-deflation cycle is ongoing in the so-called “periphery.” Rather than a central bank that helps revive growth and inflation, the ECB has become a safety net for dealing with near-insolvency conditions. 

By: Ashoka Mody Topic: Macroeconomic policy Date: December 3, 2014
Read article More on this topic More by this author

Blog Post

Monetary policy cannot solve secular stagnation alone

Larry Summers crystallized an important development and question in a recent speech given at the IMF research conference: has the world economy entered a period of “secular stagnation”? The slow recovery in the US since the financial crisis is his starting point and he argues that secular stagnation could retrospectively also explain features of previous decades such as low inflation.

By: Guntram B. Wolff Topic: Macroeconomic policy Date: October 24, 2014
Read article More by this author

Blog Post

Blogs review: The secular stagnation hypothesis

What’s at stake: On November 16, the Harvard economist and former Treasury Secretary Lawrence Summers gave a provocative talk at an International Monetary Fund conference, where he argued that an age of secular stagnation, in which the equilibrium interest rate is negative, might explain the lack of inflationary pressure we experienced in the boom years of the previous decades and the slow recovery following the 2007 crisis.

By: Jérémie Cohen-Setton Topic: Global economy and trade, Macroeconomic policy Date: August 25, 2014
Read article More on this topic



Secular stagnation in today's economy. How can it be addressed?

This video was filmed as part of the China-Europe-US Economists Symposium in Beijing. In it Gregory Claeys, Research Fellow at Bruegel, discusses secular stagnation – defined as a long period of low growth, low employment, low inflation, and low long-term interest rates. This concept, according to Claeys, could explain the current period of recovery in […]

By: Grégory Claeys and Zsolt Darvas Topic: Macroeconomic policy Date: June 17, 2014
Load more posts