Is “Secular Stagnation” a Monetary-Financial Problem or a Fundamental-Technological Problem?

On about four of the seven days in a week, my view is that the problems lumped under the heading of “secular stagnation” are primarily monetary-financial problems. Now comes Barry Eichengreen to review the case that these problems are at their root instead of also technological-fundamental. And I must say he has raised the frequency of my view that the problems are primarily monetary-financial from four days a week to five.

On the days when I think the problems lumped under the heading of “secular stagnation” are primarily monetary-financial problems, I think:

1. A failure of financial regulation has left us with a set of financial intermediaries who are untrustworthy and untrusted.
2. As a result, they cannot mobilize the risk-bearing capacity of society as a whole to any sufficient degree.
3. And, as a result, they cannot credibly promise to bear risk themselves and thus to stand behind claims that the securities they issue are low-risk.
4. Thus we see a very large spread–because of the shortage of mobilized risk-bearing capacity on the one hand and the shortage of safe assets issued on the other–between the equilibrium risky real return on investments in capital (say 5%/year) and the equilibrium real return on safe assets (say -3%/year).
5. But, with an inflation target of 2%/year, the real market rate of return on safe assets cannot fall below -2%/year.
6. Hence sometimes we have depression and low employment, as realistic assessments of real returns promised by investment in physical, intellectual, and organizational capital are not high enough to divert enough finance from safe assets with a real yield of -2%/year to reach full employment.
7. Hence in order to reach full employment we need unrealistic assessments of real returns promised by investment in physical, intellectual, and organizational capital: we need bubbles.

Note that in this view secular stagnation can be solved in any of three ways:

1. A higher inflation target that would allow for the possibility of a real safe interest rate of -4%/year would make it straightforward to induce enough finance to fund enough investment in physical, intellectual, and organizational capital to carry the economy to full employment.
2. Better financial regulation to create a financial sector that could actually mobilize the–enormous–risk-bearing capacity of society as a whole would shrink the wedge between safe and risky required rates of return from its current 8%/year or so down to something like 3%/year, or less.
3. Alternatively, a government that took on responsibility through its spending for maintaining full employment could do the job that the private sector’s shortage of risk tolerance is keeping it from doing–and in the process process it could create enough safe assets that the private sector would be eager to finance risky investment in physical, intellectual, and organizational capital as well.

But there is a view–powerfully argued by Larry Summers, if not in a manner that makes it easy for me to grasp–that a higher inflation target or a better mobilization of societal risk-bearing capacity would not be adequate solutions. What we have, instead, is a fundamental imbalance between investments that can be undertaken profitably and the savings that households and dynasties wish to hold. Such an imbalance could only be solved, the argument goes, by the government’s taking on the role of spending more and providing more savings vehicles, by income redistribution to lower the savings rate, or by policies that raise the return on investment.

Barry Eichengreen takes a look at factors that could be driving such a technological-fundamental rather than monetary-financial imbalance, and finds them thin:

Barry Eichengreen: Secular Stagnation: The Long View: “I distinguish four potential explanations…

…a rise in savings rates due to the emergence of emerging markets, a decline in investment due to a dearth of attractive investment opportunities, a decline in the relative price of investment goods, and a decline in the rate of population growth….

[In] the United States in the nineteenth century… savings rates headed back down… [after industrialization]… a hint as to what is likely to happen to savings in emerging markets…. [The] decline in the relative price of investment goods… may be reversed in the future…. Hansen’s logic was that slower population growth meant that capital had less additional labor to work with on the margin, resulting in lower returns and lower investment. What Hansen did not emphasize was that slower population growth and greater longevity also imply lower savings rates on life-cycle grounds….

A fourth explanation… is a dearth of attractive investment opportunities…. I like to distinguish… “range of applicability” and “range of adaptation.” Range of applicability refers to the number of different sectors or activities to which the key innovations can be productively applied…. Promising innovations like new tools (quantum computers), materials (graphene), and processes (genetic modification) that would seem to have a broad range of potential applications. They point to the scope for robotics to supplement human brain and muscle power in a wide range of activities…. Range of adaptation refers to how comprehensively economic activity must be reorganized before positive impacts on output and productivity growth materialize…. Thus, the steam engine had an immediate positive impact… because… its application… did not require widespread reorganization of economic activity elsewhere…. In contrast, electricity and the internal combustion engine required much more widespread adaptations before their positive impact on productivity could be felt…