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.