In those countries where governments can print their own money this does not

In those countries where governments can print their

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America, but governments have taken up the slack. In those countries, where governments can print their own money, this does not raise solvency concerns, and in the euro zone, where they cannot, public debt has risen less than in Britain and America. But again that overall figure masks differences within the group. Debt has gone down in Germany, but it has risen sharply in the periphery (see article ). These debts are bearable so long as governments can borrow at their current, low rates —2.5% in Italy, 2.2% in Spain. But if deflation sets in and nominal GDP stagnates they will become unsustainable. Investors will insist on much higher interest rates, debt will spiral upward and fears of default will fulfil themselves. As Peter Berezin of the Bank Credit Analyst , a forecast journal, says, the ECB can help a country that’s illiquid, but not one that’s insolvent. “It’s why Greece defaulted and ECB was helpless to do anything about it.” Loss of breath The most troubling effect of low inflation is on monetary policy. Central banks stimulate spending by reducing the real interest rate, which is the nominal interest rate minus the rate of inflation. This boosts investment and discourages saving, reducing the output gap. The real rate required to raise demand enough to balance investment and saving is called the equilibrium real rate. When demand is weak, the equilibrium real rate may be negative, and under low inflation it is difficult for a central bank to set a nominal rate that brings this about. And because nominal rates are in practice never less than zero (you can always just keep money in cash) deflation proper makes a negative real rate not just hard but arithmetically impossible: subtract a negative number (the inflation rate, in circumstances of deflation) from a number that has to be zero or higher and you always get something positive. While economists disagree on the current level of the equilibrium real rate, they broadly agree it is lower than in the past. According to a widely followed methodology developed by Thomas Laubach and John Williams of the Federal Reserve, America’s equilibrium real rate fell from above 4% in the 1960s, to 2% in the 1990s, and is now slightly negative. Markets seem to share that verdict. Andy Haldane, the Bank of England’s chief economist, recently noted that British markets expect real rates to remain negative for the next 40 years, probably a good approximation of the expected equilibrium real rate. This long term difficulty in matching savings and investment has been attributed to “secular stagnation”, a term coined by Alvin Hansen in the 1930s to describe the inability of the American economy to return to full employment. Those using it to describe today’s woes see it as having come about in part as a response to the recent global crisis, which made firms and households less able or willing to borrow at any given interest rate, and in part as the result of longer term trends.

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