Extract D

Figure 1: Real GDP growth rates (%) for Japan and Italy, 2016 to 2021

Figure 2: CPI Inflation rates (%) for Japan and Italy, 2016 to 2021

Extract E: The Nature of Secular Stagnation

The term 'secular stagnation' refers to a chronic shortfall of aggregate demand relative to the economy's productive capacity, resulting in persistent low growth, ultra-low inflation, and depressed interest rates. This is exacerbated by demographic shifts, such as ageing populations in developed economies saving more. High private debt levels also discourage consumption and private investment, leading to a sluggish economy.

Some economists argue this is primarily a demand deficit, which requires sustained government intervention. However, supply-side optimists claim that sluggish growth is better addressed through structural reforms—deregulating labour markets, simplifying tax codes, and fostering technological innovation. Critics of demand-side stimulus warn that excessive government borrowing risks crowding out private investment and increasing sovereign default risk, which could depress long-term growth even further.

Extract F: The limits of policy tools

For over a decade, both the European Central Bank (ECB) and the Bank of Japan (BoJ) have maintained ultra-loose monetary policies. Nominal interest rates have been pushed into negative territory, and central banks have purchased trillions of dollars of government and corporate bonds through quantitative easing (QE). Despite these unprecedented measures, economic growth has remained largely tepid, leading many economists to argue that monetary policy has run its course and is now 'pushing on a string'.

If monetary policy has become ineffective, attention naturally shifts to fiscal policy. However, both regions face massive hurdles to fiscal expansion. Japan's public debt exceeds 260% of GDP, while Italy's public debt climbed above 150% of GDP following the COVID-19 pandemic. Under Eurozone fiscal rules, member states face strict deficit and debt limits. However, proponents of fiscal expansion argue that when central bank policy rates are near zero, the fiscal multiplier is high. Large-scale public investment in infrastructure, digital connectivity, and green energy may be the only sure way to lift these developed nations out of their stagnation. What is not clear is what should be done if low inflation and weak demand turn into a permanent low-growth trap.