BoE paper warns escape from secular stagnation may ‘beggar thy self’

Escaping secular stagnation may be possible by winning a currency war, but the outcome could be to “beggar thy self” rather than “beggar thy neighbour”, according to a staff working paper published by the Bank of England.

Step away from the zero lower bound builds on recent work on the global negative spillovers caused by efforts to escape secular stagnation, instead looking at the domestic equilibrium. Giancarlo Corsetti, Eleonora Mavroeidi, Gregory Thwaites and Martin Wolf build a framework to study the effects for a small open economy.

The authors show that an economy can escape the world of chronic deflation and deficient demand implied by the secular stagnation hypothesis by achieving a currency devaluation in real terms. To cope with global deflation, the country must continue depreciating the currency in nominal terms.

However, despite the return to trend inflation and growth, the net impact on domestic welfare may be negative, they warn. The depreciation reduces incomes in real terms and may exacerbate financial constraints within the economy.

“Currency wars, in this context, can be ‘beggar thy self’, rather than ‘beggar thy neighbour’,” the authors say.