Reserve Bank of Australia (RBA) governor Glenn Stevens made headlines last week by suggesting economic growth below 3% is the new normal.
As he put it: "Perhaps the growth we have seen is in fact closer to trend growth than we thought." During the past five years, Australian GDP growth has averaged just 2.5%
Although he didn't use the words, it seems that Stevens has bought into the economic theory of secular stagnation, whose most forceful recent proponent has been former US Treasury secretary Larry Summers. And if he's right then we are set for a big, ongoing debate about the role of fiscal policy in economic management.
Secular stagnation posits that there has been a permanent lowering of the equilibrium real rate of interest – and hence potential stable growth rate of advanced economies – because of a shift in the supply of, and demand for, savings.
In short, there is too much money chasing too few investment opportunities.
This shift probably occurred after the massive productivity gains from the 1990s information technology revolution tapered off. But the shift was masked by the huge real estate bubble in the US and elsewhere in the 2000s.
Indeed, in Summers' view, the only reason the US economy did not overheat during the housing bubble was because of the underlying decline in potential growth.
Why is the RBA just coming to this realisation now, when it seems to have been apparent elsewhere for some time? Well, unlike the US, Australia experienced a massive mining boom that provided huge productive investment opportunities. Until recently.
Arguably, the mining boom was the thing that masked secular stagnation in Australia the way the housing bubble did in the US. Australia, too, has seen a massive run up in housing prices, but relative to the US this was driven more by people trading existing housing stock at higher and higher prices, rather than overpaying for newly built houses in Las Vegas and Arizona. Or Dublin, Ireland for that matter. Now that the mining boom is over, Stevens' new normal is there for all to see.
This depressing scenario (pun sort of intended) raises the obvious question of what might be done about it.
That's a vital question because of what a growth rate with a 2 in front of it means for unemployment and the federal Budget. Don't forget that the 2015 Budget assumed economic growth in 2016-17 would be 3.25% and that unemployment would peak at 6.5%. Not only is it an important question, it's bound to be a controversial one in that it puts at centre stage the role of fiscal policy in managing economic growth.
The need for large-scale government spending opens the door to every wasteful pet project imaginable. We could quickly be facing 'pink bats on steroids'
There are broadly two options to address this decline. The first is to reduce the actual rate of interest. Unlike the US, Australia has room to move on short-term interest rates. Exactly 200 basis points of room.
But it is unclear that further reductions in rates will have much more effect given the large cuts that have already occurred. Reducing long-term interest rates through bond-buying programs (quantitative easing) is also possible, but may fuel asset price bubbles.
Still, given the economic slowdown, interest rate cuts seem prudent. But they can only go so far, and achieve so much, before we hit the so-called zero lower bound. Indeed, if one thinks that the real rate of interest is now negative then it's impossible to match the actual interest rate to it.
That logic leads to the second possible response: provide the missing investment opportunities being chased by over-abundant saving. The best prospect here is large-scale infrastructure investments – something Australia sorely needs.
These, of course, cost money. But precisely because of low interest rates, governments can borrow very cheaply. However, this sounds all a bit Keynesian and certainly doesn't fit well with the Coalition's focus on debt and deficits. And this sort of spending may not be short-term, unlike in response to a recession.
In fact, if the secular stagnation hypothesis is right, then low growth is not the only new normal we will need to get used to. We will have to reboot the old debates about government spending.
If monetary policy is less effective than it used to be then the spotlight will shift to fiscal policy. Yet the need for large-scale government spending opens the door to every wasteful pet project imaginable. We could quickly be facing 'pink bats on steroids'.
To combat this, we will have to start thinking about government spending in two distinct categories: investment and recurrent spending.
Investment in infrastructure should be treated like a business treats capital expenditure and charged to the bottom line over its useful life, not in one hit when the investment is made. And it should be subject to the same kind of cost-benefit calculations that private enterprise performs.
If Stevens is right, and secular stagnation has hit Australia, then we will not only need to get used to low growth, but a more nuanced public debate around spending programs.
And Tony Abbott may get his wish: to go down in history as "the infrastructure Prime Minister".
Richard Holden is a professor of economics at UNSW Business School. A version of this post appeared in The Australian Financial Review.