Peter Praet, Executive Board Member of the ECB:

Central to this debate is whether the slow growth can be attributed to cyclical – and hence ultimately transitory – factors related to the financial crisis, longer-term structural factors, or a combination of both, whereby cyclical factors have over time turned into permanent factors, for example via hysteresis effects.

Longer-term structural factors have certainly been at play in the euro area. The decline in potential output growth pre-dates the financial crises, in fact going back to the mid-1990s, and reflects a long-term slowdown in the growth of total factor productivity. This decline went largely unnoticed. To some extent this oversight can be explained by the fact that in the decade leading up to the crisis the overall macroeconomic environment had been stable. Remember our debates during the Great Moderation and all the good reasons that were put forward to explain macroeconomic stability!

Today we can look back at this period and see the expectation gaps that we could not clearly identify in real-time. In various parts of the euro area, firms’, households’ and governments’ future income expectations had become disconnected from underlying growth, leading to an accumulation of excess debt. Those over-optimistic expectations were in turn reinforced by this renewed, yet complacent sense of economic prosperity.

So when the cycle did finally turn in 2008, several euro area countries were confronted with pronounced “balance sheet recessions”: downturns created by the need for both private and public sectors to deleverage. This has produced a set of circumstances – a protracted slump – that are observationally equivalent to those that one would associate with secular stagnation. But it is important that we distinguish this from the longer-term slowdown in potential output, since it remains ultimately a cyclical phenomenon and hence amenable to different policy tools.

Read the whole thing: Is secular stagnation the new economic reality?

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