Secular Stagnation? Seriously?

Paul Krugman endorses the idea. Pointer from Mark Thoma.

My own first reaction to Larry Summers’ talk was to write

there are so many problems with Summers’ story that one does not even know where to begin.

Tyler Cowen writes,

I don’t mean this in a rude or polemic way, but the arguments we have been reading do not yet make sense.

Cowen’s stagnation story is that the pace of innovation has slowed, resulting in declining growth in aggregate supply. In contrast, Summers’ story is one of a permanent shortfall of aggregate demand, due to an excess of desired saving over desired investment, which can only be eliminated at a negative real interest rate.

Here are some criticisms that come to mind.

1. If “the” full-employment real interest rate is negative, then why do we need quantitative easing? Why does not the excess of saving over investment not by itself drive long-term rates to zero?

2. Summers wants to claim that full employment has been achieved in recent years because of asset bubbles. However, in a world of negative real interest rates, there is no such thing as an asset bubble. Real assets have infinite value in such a world.

3. As Tyler points out, it is hard to reconcile positive economic growth with negative real interest rates. We have had positive economic growth, even since 2008.

4. As Tyler also points out, we observe higher interest rates for risky assets. In fact, if you want to understand the low interest rates that Summers and Krugman are talking about, then my suggestion is to “follow the guarantees.” In one way or another, the U.S. government has provided a guarantee on many investments. Government bonds are one example. Mortgages are another.

5. The prime rate at banks averaged 5 percent from 2001-2004, almost 7 percent from 2005-2008, and 3.25 percent from 2009-2012. Inflation over these periods averaged 2.3 percent, 3.4 percent, and 1.5 percent respectively, so that the real rate of interest has been positive throughout.

6. Summers’ revival of the secular stagnation hypothesis has not been broadly peer reviewed. Before people jump on the bandwagon, I would wait until it has been evaluated by a broader range of economists.

11 thoughts on “Secular Stagnation? Seriously?

  1. Is not necessarily “technology” which is the principal driver in the expansion of a culture or of the expansion of a civilization composed of such cultures.

    The expansion of cultures in Northwestern Europe, England and the United States in particular has been founded upon the predominance of individuality in those cultures.

    As that predominance has been diluted by the predominance of individuals preferring to avoid the risks and responsibilities of choices, and to eliminate comparison to the characteristics of individuality which not only accept but seek those choices and their consequences, individuality has been suppressed and is currently in recession, as it has happened in the historic past.

    As a major factor of that suppression the endogenous regulation of the life of individuality is now largely replaced in Western civilization by external regulation and constraints.

    However, some degree of individuality is required within every culture to sustain the necessary creative responses to the challenges created by human interactions, fortuitous events, and the generally desired sense of betterments to conditions.

    The early evidence of the recession of individuality can be seen in the fragmentation of the cultures within Western civilization. Those cultures are also being confronted with external intrusions which only individuality can produce the spontaneous creativity for appropriate reaction. It is possible that the external intrusions may create situations that will in the suppression of individuality. So far that does not appear likely.

  2. I don’t really understand much of this. Is there something I could read to help me understand specifically numbers 2 & 3? Thanks

  3. “The prime rate at banks averaged 5 percent from 2001-2004, almost 7 percent from 2005-2008, and 3.25 percent from 2009-2012. Inflation over these periods averaged 2.3 percent, 3.4 percent, and 1.5 percent respectively, so that the real rate of interest has been positive throughout.”

    Ask anyone in banking, the prime rate has nothing to do with anything. A more relevant point may be that real rates for Investment Grade corporate bonds have been positive.

    While that is true, they have been barely positive and much lower level on an absolute level. And that is after factoring in significant amount of credit risk.

  4. Here are some rebuttals to the criticisms that come to mind.

    1. We need QE to drive long-term rates to zero quicker than what would happen without intervention.

    2. There is no such thing as infinite value, so please readjust your model.

    3. It may be hard to reconcile, but it must be done. Akin to point #2.

    4. Not inconsistent with the Krugman/Summers model: everything is shifted a few percent down, so that the safest assets are in fact yielding negative return.

    5. The data is wrong.

    6. Fair point. I am that broader range.

    • Agree and some further points:

      1. Because (this is a subtel but hugely important point) of the word credit in the traditional sense of “trust”. There are multiple equilibria. One of them is a collapse in trust, the spiral of deleveraging and universal insolvency (in nominal money terms). QE pushes the system towards the other equilibrium.

      2. Real assets won’t have infinite values. A hypothetical asset that produces infinite stream of real income would (assuming this income stream comes at a risk premium lower than the real rate is negative). But such assets don’t exist. The Samuelson example of levelling the hill to make the railroad save energy that Bernanke cited is a good one — what are the odds that this railroad transport service will be needed infinitely? Zero.

      3. Other than data problems (growth came in health and education — cost+ types of industries where the outcomes are not observable) there is also no functional link between real rate and economic growth. You can have all growth accrue to innovators, not savers.

      4. Unclear how this relates to the “negative rate” idea.

      5. That real rate to end borrowers staying positive is exactly the reason there hasn’t been any real recovery.

  5. Re #1: I think IOER plays a large part on keeping a floor on short-end rates. If short-end rates cannot go negative, then long-end rates (expected short rates over the term) have that floor.

  6. Without QE, interest rates on Treasury bonds would have gone negative yet still be positive. There is a lack of real savings in the system, so it is replaced with QE. The QE policy could be renamed “Saving the Debts!” The market would like to have extremely high real interest rates (via collapsing asset prices and negative GDP), the goal of QE is to get them as low as possible. Without QE, “everyone” would move into Treasuries and out of risk assets. With QE, they sell their Treasuries to the Fed and buy risk assets. Krugman et al want to turn up the volume on this policy.

    Krugman derides the deflationists, he says the financial crisis is 4 years behind us, but his policy makes perfect sense to someone who thinks the financial crisis hasn’t ended at all, but is merely being forestalled by QE. If they can get inflation high enough, the debts will become sustainable.

    Their main problem is that they can’t print borrowers, and Uncle Sam is not an good investor.