The Economy May Be Stuck in a Near-Zero World

The Economy May Be Stuck in a Near-Zero World

Credit Maria Nguyen

When the Federal Reserve lowered interest rates to close to zero during the financial crisis, it was an extraordinary move. The central bank had hit the limits of conventional monetary policy, leaving the recovery to sputter along with less help than it needed.

Now, with that crisis at last behind us, the Fed has begun raising interest rates, and it may be tempting to view its brush with rock-bottom rates as a once-in-a-lifetime experiment and to assume that we are entering a more normal world.

If only that were true. A new study suggests that near-zero interest rates — accompanied by a lackluster recovery — may become a common occurrence.

In a nutshell, the American economy appears to have changed in a way that undermines the effectiveness of monetary policy but not fiscal policy, which may need to be wielded more actively.

All of this is the result of two broad trends. First, inflation is lower than in the past. From 1950 through 2011, it averaged around 3.5 percent. In January 2012, the Federal Reserve committed to a target of 2 percent, and actual inflation levels have been even lower.

Second, the real (inflation-adjusted) interest rate consistent with the economy operating at its full potential has fallen, a trend that the Harvard economist Lawrence H. Summers called “secular stagnation.” Most estimates suggest that this “neutral real interest rate” has dropped from around 2.5 percent to 1 percent, or lower.

Put these pieces together, and a conservative guess is that in “normal times,” the nominal interest rate — the neutral real interest rate plus inflation — has fallen from around 6 percent to 3 percent.

That creates a serious problem for the Fed. Here’s why: Most recessions can be cured by lowering rates by several percentage points. When interest rates were closer to 6 percent, the Fed could lift the economy with plenty of interest-rate leeway.

But when normal interest rates are closer to 3 percent, the Fed can cut rates only a few times, because rates can only go so low — perhaps as low as zero, maybe a tad lower. This means that in even a typical downturn, the Fed may be unable to cut rates as much as it would like.

Even worse, this limit is a far bigger problem when an economic downturn follows closely on the heels of a previous recession. Right now, for instance, the central bank’s main short-term rate, the federal funds rate, is still only three-quarters of a percent to 1 percent, because the Fed wants to continue stimulating the recovery. This leaves the central bank with very little room to respond if the economy falters. Even a minor slowdown now could require a larger rate cut than is feasible, once again leaving policy makers wishing they could do more.

This dynamic can feed on itself. The less ammunition the Fed has to blast the economy out of its malaise, the weaker and slower will be the recovery, making it more likely that the next bad shock will require the Fed to cut rates more than is feasible.

To assess these problems, two senior Federal Reserve economists, Michael T. Kiley and John M. Roberts, ran hundreds of simulations in the Fed’s large-scale macroeconomic model, evaluating how the United States would perform in response to the sorts of shocks that have historically buffeted the economy.

But times have changed. When the economists set the normal interest rate at 3 percent and let the Fed adjust interest rates as conditions warranted, rates moved down to zero percent and could not move any lower roughly a third of the time. In some of these cases, the economy didn’t need much extra punch, and so this slowed the recovery only a little. In others, it was a more telling constraint, and it took years for the economy to return to normal.

Their research paper, “Monetary Policy in a Low Interest Rate World,” which was presented at a recent meeting of the Brookings Papers on Economic Activity, explains why this is so worrisome.

The problem is that a lower bound on interest rates creates a sharp asymmetry in how the economy works: It’s relatively easy for the Fed to cool an overheating economy by raising rates. But when the economy is already cooling down, the central bank may not be able to cut rates enough to prevent a recession or to spur a strong recovery. Downturns will be deeper and more common than upswings. This means that, on average, output will be lower than it needs to be — perhaps more than a percentage point lower — and inflation will be lower than the Fed’s 2 percent target. Joblessness will be more common, particularly during slumps.

It is crucial, therefore, that macroeconomic policy adjusts to these problems before the next downturn hits.

The Fed has already been experimenting with monetary policy, but it hasn’t been enough. In the wake of the financial crisis, for example, it bought bonds in a program known as quantitative easing, cutting long-term interest rates once short-term rates were near zero. The resulting stimulus was relatively small, reducing long-term rates by only a fraction of a percentage point, and the program was politically unpopular.

The authors suggest an alternative approach in which the Fed makes up for “missing stimulus” by promising to keep rates lower, for longer periods. In their view, the Fed needs to make up for the interest rate cuts that it wishes it could have made, but couldn’t. Promising this in the depths of a downturn would offer businesses reason to be optimistic, they say, boosting the recovery. The Fed would need to keep rates low, even as inflation overshot its target.

It’s a promising approach, but would people really believe the Fed’s promises? I know a lot of central bankers, and I fear they are incapable of sitting still while inflation rises above their stated target.

Perhaps the answer lies outside the Fed. It may be time to revive a more active role for fiscal policy — government spending and taxation — so that the government fills in for the missing stimulus when the Fed can’t cut rates any longer. Given political realities, this may be best achieved by building in stronger automatic stabilizers, mechanisms to increase spending in bad times, without requiring Congressional action.

There’s an opportunity to wed this to President Trump’s desire for more infrastructure spending. Rather than building more roads today as the economy approaches full employment, we should spend more when the economy is weak and the Fed is unable to provide enough stimulus. One way that this could be done is by automatically increasing the Highway Trust Fund when the federal funds rate hits zero and perhaps ramping up spending the longer that rates are stuck there. More roads would be built when they do the most good for the economy.

This idea reverses a decades-long trend away from active fiscal policy. The general distrust of fiscal policy may well have made sense; many economists are more likely to trust the technocrats at the Fed to manage the business cycle than the election-driven politicians on Capitol Hill. But in a world of low interest rates in which the Fed is frequently hamstrung, we may not have that choice.


When Solar Panels Became Job Killers

When Solar Panels Became Job Killers

Workers for Wuhan Guangsheng Photovoltaic Company installing solar panels on a roof in Wuhan, China. China is home to two-thirds of the world’s solar-production capacity, and buys half of the world’s new solar panels. Credit Giulia Marchi for The New York Times

WUHAN, China — Russell Abney raised two children on solar power. The 49-year-old Georgia Tech graduate worked for the last decade in Perrysburg, Ohio, a suburb of Toledo, pulling a good salary as an equipment engineer for the largest American solar-panel maker.

On the other side of the world, Gao Song boasted his own solar success story. A former organic fruit retailer who lives in the dusty Chinese city of Wuhan, he installed solar panels on his roof four years ago and found it so lucrative that he went into business installing them for others. By last summer, he and a team of 50 employees were installing solar-panel systems on nearly 100 roofs a month.

Then China shook the global solar business — and transformed both their lives.

“A small vibration back in China,” said Frank Haugwitz, a longtime solar industry consultant in Beijing, “can cause an avalanche in prices around the world.”

China’s solar-panel makers cut their prices by more than a quarter to compensate, sending global prices plummeting. Western companies found themselves unable to compete, and cut jobs from Germany to Michigan to Texas and points beyond.

Those points included Perrysburg — where Mr. Abney and about 450 other employees suddenly found themselves out of work. “Within just a few months, it all came crashing down,” Mr. Abney said. “It’s like a death in the family. People feel awkward talking about it.”

President Trump, who pressed President Xi Jinping of China on trade and other issues this week when they met at Mar-a-Lago in Palm Beach, Fla., has vowed to end what he calls China’s unfair business practices. Much of his oratory has involved old-fashioned smokestack industries like steel — industries in which the jobs were already disappearing even before the rise of China.

But economists and business groups warn that China’s industrial ambitions have entered a new, far-reaching phase. With its deep government pockets, growing technical sophistication and a comprehensive plan to free itself from dependence on foreign companies, China aims to become dominant in industries of the future like renewable energy, big data and self-driving cars.

Russell Abney lost his job as an equipment engineer for a United States-based company when China’s solar-panel makers cut their prices by more than a quarter. Credit Matt Roth for The New York Times

With solar, it has already happened. China is now home to two-thirds of the world’s solar-production capacity. The efficiency with which its products convert sunlight into electricity is increasingly close to that of panels made by American, German and South Korean companies. Because China also buys half of the world’s new solar panels, it now effectively controls the market.

For much of the past century, the ups and downs of the American economy could spell the difference between employment or poverty for people like Chilean copper miners and Malaysian rubber farmers. Now China’s policy shifts and business decisions can have the same kind of global impact once wielded by power brokers in Washington, New York and Detroit.

The story of China’s rise in solar panels illustrates the profound difficulties the country presents to Mr. Trump, or to any American president. Its size and fast-moving economy give it the ability to redefine industries almost on a dime. Its government-led pursuit of dominance in crucial industries presents a direct challenge to countries where leaders generally leave business decisions to the businesses themselves.

Already, China is the world’s largest maker and buyer of steel, cars and smartphones. While it does not necessarily dominate those industries, its government ministries are moving to replicate that success with robots, chips and software — just as in solar.

Chinese panel makers “have the capital, they have the technology, they have the scale,” said Ocean Yuan, the chief executive of Grape Solar, a distributor of solar panels based in Eugene, Ore. Of American rivals, he said, “they will crush them.”

Rooted in Fish

Before he became one of the solar industry’s most powerful players, Liu Hanyuan raised fish.

The son of peasants from China’s hardscrabble southwest, Mr. Liu sold some of the family’s pigs in 1983 for what was then around $100 to buy some fish. Soon he went into the even more lucrative business of selling fish feed, and he eventually moved into pig feed and duck feed. The brand name, Keli, is a combination of the first and last Chinese characters from a famous paraphrasing of Karl Marx by Deng Xiaoping, the father of modern China: Science and technology are primary productive forces.

According to Mr. Liu’s authorized biography, he faced local criticism at first for his early embrace of capitalism, and responded by saying that his fish feed was an improved product that followed Deng’s dictum. “When my business grows bigger,” he said at the time, “I will build another floor for labs.”

Plans to shift into computer chips did not pan out, so by 2006, he shifted to solar technology, after taking control of a company that made chemicals for the production of polysilicon, the crystalline raw material for solar panels. That move proved fortunate: China was just then embarking on a concerted effort to become a solar-industry powerhouse.

Building More Factories

China has led the world in solar panel production. But recently, Chinese companies have been building factories outside China, particularly in Malaysia and Vietnam, to bypass anti-dumping and anti-subsidy measures that the United States and European Union imposed on Chinese-made panels four years ago.




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Over the next six years, Beijing pushed state-owned banks to provide at least $18 billion in loans at low-interest rates to solar-panel manufacturers, and encouraged local governments to subsidize them with cheap land. China had more on its mind than just dominating solar exports: Its severe pollution problems and concerns that rising sea levels from climate change could devastate its teeming coastal cities lent urgency to efforts to develop green technology. At the same time, China also became a major player in wind power through similar policies.

With ample assistance, China’s solar-power production capacity expanded more than tenfold from 2007 to 2012. Now six of the top 10 solar-panel makers are Chinese, including the top two, compared with none a decade ago. The solar division of Mr. Liu’s company, the Tongwei Group, which discloses few financial details, is one of the fastest-expanding players in the industry.

That growth forced many American and European solar-panel manufacturers into a headlong retreat. Two dozen of them filed for bankruptcy or cut back operations during President Barack Obama’s first term, damaging the heady optimism then about clean energy.

In 2012 and 2013, the United States and the European Union concluded that Chinese solar-panel makers were collecting government subsidies and dumping panels, or selling them for less than the cost of producing and shipping them. Both imposed import limits. Chinese manufacturers and officials denied improper subsidies and dumping, and still do.

Several large Chinese manufacturers that had previously overexpanded and had been selling at heavy losses for years then closed their doors. But Western solar companies say Chinese banks still lent heavily to the survivors despite low loan-recovery rates from the defaults of big Chinese solar companies like Suntech, Chaori and LDK Solar.

“The main subsidy is massive, below-market loans by Chinese state-owned commercial banks to finance new capacity and also the massive ongoing losses of Chinese companies,” said Jürgen Stein, the president of American operations for SolarWorld, a big German panel maker.

High-Tech Hopes

Like the Chinese solar industry as a whole, Tongwei is thinking bigger.

Mr. Liu’s company bought an enormous solar-panel manufacturing complex in central China in 2013 from LDK Solar, which had run into severe financial difficulties. Now it plans to build factories of five gigawatts apiece in the Chinese cities of Chengdu and Hefei. By comparison, the entire global market is only about 77 gigawatts each year, while world capacity is 139 gigawatts.

Technicians from Yingli Solar working on a solar panel at the company’s headquarters in Baoding, Hebei province. Credit Kevin Frayer/Getty Images

At the same time, Mr. Liu is dismissive of companies in the West that pioneered many solar technologies but have lost their market shares to China. “They are very jealous,” he said, “and cannot catch up with China’s pace.”

From an environmental standpoint, China’s solar push has been good for the world. Solar-panel prices have fallen close to 90 percent over the past decade. Many of the solar panels in America’s backyards and solar power plants are made by Chinese companies.

But for the solar industry, Chinese expansion could mean an extended period of low prices and cutbacks for everybody else.

“The solar industry is facing again, I would say, a new winter,” said Patrick Pouyanné, the chairman and chief executive of Total, the French oil and gas giant, which owns a controlling stake in SunPower, an American solar-panel maker.

China now hopes to replicate its solar industry’s growth in other areas.

Under a plan called Made in China 2025, China hopes to become largely self-sufficient within seven years in a long list of industries, including aircraft, high-speed trains, computer chips and robots. The plan echoes the solar-panel and wind-turbine buildup a decade ago, but with a larger checkbook. Made in China 2025 calls for roughly $300 billion in financial backing: inexpensive loans from state-owned banks, investment funds to acquire foreign technologies, and extensive research subsidies.

If successful, Made in China 2025 would represent a fundamental shift in how China deals with the world. Initially, most of the industries that moved to China, such as shoe and clothing production, were already leaving the United States anyway. Heavy industries such as steel followed. While the shift was profound — some economists estimate that up to 2.4 million American jobs were lost to China from 1999 to 2011, though others dispute that analysis — China has struggled in some areas like autos to create viable global competitors.

American and European business groups have warned that the China 2025 plan means that a much wider range of Western businesses will face the same kind of government-backed competition that has already transformed the solar industry.

Gao Song, owner of the solar company Wuhan Guangsheng Photovoltaic Company, using a drone to inspect a rooftop where his workers were installing solar panels.

Credit Giulia Marchi for The New York Times

Ripples From Wuhan

In the end, China did not slash subsidies for rooftop solar panels, and cut them only slightly for large power-plant arrays. But prices barely rebounded from last year’s slump.

Mr. Gao, of Wuhan, is a slender 37-year-old whose dark hair is already thinning. He said that his business had depended not on homeowners but on profit-minded investors who made use of the subsidies.

The investors would pay three-fifths of the cost of a homeowner’s system. The homeowner would take only enough electricity from the panels to power the home. The investor would sell the rest of the electricity to the grid at a high, government-assisted price.

The suggestion that the government might cut the subsidy, even though the government did not follow through on it, panicked his investors. So they stopped financing further deals.

“They fear that the year after next, they may have nothing,” he said. He recently hired four more employees to drum up sales, even as installations creep along at a small fraction of demand a year ago.

In Perrysburg, Mr. Abney lost his job at First Solar, the largest solar-panel manufacturer based in the United States, and looked in vain for a job in the auto industry in the Toledo area. He ended up taking a job three weeks ago at a building materials company in Lancaster, Pa. His daughter is going off to college in the autumn, while his wife and son, a high school freshman now, will follow him to central Pennsylvania this summer.

“It’s hardest on him because we’re pulling him away from his high school and his activities,” Mr. Abney said.

First Solar struggled with improving Chinese technology as well as dropping prices.

It laid off workers in Perrysburg partly because it decided not to produce its Series 5 generation of panels, which represented a limited improvement over its existing Series 4 panels. First Solar, to better compete with Chinese producers, will wait for its lower-cost, high-efficiency Series 6 panels to be ready for production in 2018. In the end, First Solar, which is based in Tempe, Ariz., laid off 1,600 people worldwide.

“It’s just kind of a shock factor when a lot of families realize they’re no longer going to have a job,” said Michael Olmstead, the Republican mayor of Perrysburg.

Though Mr. Abney has started his new job at almost the same pay as his previous one, he says part of him pined for the days when the United States still led in solar energy, and when First Solar was at the forefront of that leadership.

“They were good for us,” he said. “And it was great while it lasted.”