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Secular Stagnation in the Eurozone

Ultra-low interest rates, inflation below target, underwhelming potential output growth – this has been the situation in the eurozone at least since interest rates fell close to zero in 2013, raising the question of whether this is some kind of “new normal.” In other words – to use the term popularised by Larry Summers – is the eurozone in secular stagnation?

Our analysis suggests that the answer is yes. Lower fertility, higher longevity, sluggish TFP growth, a global savings glut, and several other secular forces have combined in a kind of perfect storm to push interest rates below zero. Simultaneously, these secular forces have led to a situation of persistently deficient aggregate demand, which the ECB now cannot stimulate anymore with conventional tools as its policy rates are close to their effective lower bounds. To a lesser degree, the same forces also induce a weakness in aggregate supply, where falling productivity, a shrinking labour force, and subdued investment depress potential growth. Hence, while the eurozone’s secular stagnation is primarily demand-driven, it also depresses the supply side, so that inflation will remain below target even when the output gap closes.

Ultimately, the key issue for policymakers and business leaders is how long this situation will persist and what the economy needs to get back to normal. Answering this question is the objective of this paper, where we disentangle the many forces that have been pushing interest rates in the eurozone down since the 1980s and quantify their impact. This enables us to compute counterfactuals of what’s needed for real short-term market rates to rise back to normal, say to 1%.

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