Summers claims that some sort of exogenous shock has reduced the long run real interest rate on safe assets.
That is not what I heard. Go back and listen to Larry’s response to Jeff’s question. Larry is talking about a savings glut and a decline in the cost of physical capital.
Think of an economy with three assets: money, risk-free Treasuries, and physical capital. What I heard Larry saying was that because of the savings glut and the low price of computers, the full-employment real return on physical capital is negative. That is a silly idea and a false idea, but that is what I heard Larry say. Ben Bernanke heard the same thing.
What Scott heard Larry say was that the demand for risk-free Treasuries is high, but the demand for physical capital is not so high, so that there is still a sizable risk premium on risky assets. My comments:
1. That may be a good story for, say, the fourth quarter of 2008. Larry claims to be talking about a decades-long phenomenon, pre-dating the crisis and continuing into the indefinite future.
2. The policy implications of that story are somewhat different than the policy implications of “secular stagnation.” If there is too much savings, then Larry wants to argue that the government needs to use up the savings. If what is holding back investment is high risk premiums, then more government spending is not such an obvious remedy.
You made me go back and listen to Larry once again, and yes he says the ultimate cause is zero short term interest rates. But nothing struck me as saying it was the savings glut, so here I go for a third time.
He starts by saying that private sector financiers do not handle risk appropriately. He documents the unexpected low growth in all OECD nations. Then goes into network theory, but then applies that theory to finance. (The qualifies, “If that [bad financial management] what was the problem”. Then he once again points to rates hitting zero bound. Finally he talks about ‘natural, equilibriating’ forces for low growth over time. Then he points out that in the presence of a natural underlying negative growth, then policy would be inefficient if this trend were unnoticed.
Then in conclusion he says, fake rates ultimately measure growth and growth has been declining due to one or more unnoticed negative growth trends called secular stagnation, and the problem may be common across developed nations. He never stated the cause of secular stagnation and left it up to us to postulate a long term physical cause,.
“What I heard Larry saying was that because of the savings glut and the low price of computers, the full-employment real return on physical capital is negative. That is a silly idea and a false idea, but that is what I heard Larry say. Ben Bernanke heard the same thing.”
I listened just now to Larry’s talk and his response to Jeff’s question, and this is definitely NOT what I heard him saying (nor do I see any evidence that this is what Ben Bernanke heard). Larry implies (doesn’t even quite say) that, because of the savings glut and the low price of computers, the full-employment real return of physical capital is LOWER than it was BEFORE and that perhaps it is so low now that it implies a full-employment real interest rate (which I interpret to mean risk-free rate) of less than -2%.
During the talk, all his references are to the interest rate (which I think, in context, since he is talking about monetary policy, must be a nearly risk-free short-term rate like the federal funds rate); none of those references are to the return on physical capital. When Jeff asks why this might be, Larry speculates that cheap capital goods are the problem. He doesn’t actually say anything about the RETURN on physical capital. He says that, since a little bit of savings can now buy a lot of capital, there is more physical capital investment required, in real terms, to use up a given amount of savings. He doesn’t say what exactly this implies about the equilibrium return, but clearly he thinks it is lower than it used to be, because you now have a huge amount of real savings (if you deflate the savings using a price index for capital goods) chasing a not necessarily huge number of capital investment projects, so you’re going to have to start funding the ones that have low returns. Nothing in what he says suggests that the equilibrium return is necessarily negative.
It is surprising how many intelligent people reacted with tissue rejection to Summers’ commonsensical idea. There is no law of nature that intertemporal returns on capital have to be positive. When in an ageing society the baby boomers trade the capital they create today for the labor of the future young people, they are in a pretty bad bargaining position.
Demographics, yes Krugman mentioned it in a passing reference to secular stagnation. Larry made no mention as I recall.