Must-Read: Ken Rogoff (2015): Debt Supercycle, Not Secular Stagnation

Must-Read: For a year and a half now I have been trying to understand what this passage means, especially the “in a world where regulation has sharply curtailed access for many smaller and riskier borrowers, low sovereign bond yields do not necessarily capture the broader ‘credit surface’ the global economy faces”. In a world in which n + g > r_{safe, why isn’t issuing more safe debt, rolling it over forever, and spending the resources buying useful stuff not win-win ex ante for everyone? Who are supposed to be the losers from this, in the sense that acting on these price signals reduces well being because they are “distorted” and “do not necessarily capture the broader ‘credit surface’ the global economy faces”?}

Ken Rogoff (2015): Debt Supercycle, Not Secular Stagnation: “Low real interest rates mask an elevated credit surface…

…What about the very low value of real interest rates? Low rates are often taken as prima facie by secular stagnation proponents, who argue that only a chronic demand deficiency could be responsible for steadily driving down the global real interest rate. The steady decline of real interest rates is certainly a puzzle, but there are a host of factors. First, we do not actually observe the true economic real interest rate; that would require a utility-based price index that is extremely difficult to construct in a world of rapid change in both the kinds of goods we consume and the way we consume them. My guess is that the true real interest rate is higher, and perhaps this bias is larger than usual. Correspondingly, true economic inflation is probably considerably lower than even the low measured values that central banks are struggling to raise.

Perhaps more importantly, in a world where regulation has sharply curtailed access for many smaller and riskier borrowers, low sovereign bond yields do not necessarily capture the broader ‘credit surface’ the global economy faces (Geanokoplos 2014). Whether by accident or design, banking and financial market regulation has hugely favoured low-risk borrowers (governments and cash-heavy corporates), knocking out other potential borrowers who might have competed up rates. Many of those who can borrow face higher collateral requirements. The elevated credit surface is partly due to inherent riskiness and slow growth in the post-Crisis economy, but policy has also played a large role. Many governments, particularly in Europe, have rammed down the throats of pension funds, banks, and insurance companies. Financial repression of this type not only effectively taxes middle-income savers and pensioners (who receive low rates of return on their savings) but also potential borrowers (especially middle-class consumers and small businesses), which these institutions might have financed to a greater extent if they were not required to be so overweight in government debt.

Surely global interest rates are also affected by the massive balance sheet expansions that most advanced-country central banks have engaged in. I don’t believe this is as important as the other effects I have discussed (even if most market participants would say the reverse). Global quantitative easing by advanced countries and sterilised intervention operations by emerging markets have also surely had a very large impact on bringing down market volatility measures.

The fact that global stock market indices have hit new peaks is certainly a problem for the secular stagnation theory, unless one believes that profit shares are going to rise massively further…