What’s behind the decline in U.S. interest rates?

Photo of the Marriner S. Eccles Federal Reserve Board Building in Washington, D.C.

There are many ways to think about secular stagnation, but one particularly useful way is to look at the natural rate of interest. Secular stagnation can be thought of as the idea that the natural rate of interest, or the interest rate at which the economy is at full potential, is permanently negative. The long-term decline in interest rates across high-income countries poses significant problems for macroeconomic policy if the Federal Reserve and other central banks can’t push interest rates low enough to drive the economy to potential during a downturn.

What’s behind the decline in interest rates? And could the trend be reversed anytime soon?

A new paper by economists Gauti Eggertsson of Brown University, Neil Mehrotra of the Federal Reserve Bank of Minneapolis, and Jacob Robbins of Brown University takes a look at secular stagnation and the forces behind declining U.S. interest rates.

The majority of the paper presents a model of the macroeconomy that allows for the natural rate of interest to be negative for an extended period. New Keynesian models, the kind mostly preferred by central banks, don’t allow for such a possibility. So let’s be clear that the results about the forces behind the decline in the interest rates are dependent upon this model being an accurate map of reality.

Using their model, Eggertsson, Mehrotra, and Robbins decompose the roughly 4 percent decline in the natural rate of interest since 1970. These factors all affect either the supply of savings or the demand for loans. The changes in the supply and demand end up changing the price of savings and the price of loans—the interest rate. They find four large forces that have affected the natural rate during the 45-year period: three that pushed the rate down and one that pushed it upward.

The first two factors are related to demographics. First, the decline in mortality helped push down the natural rate by about 1.8 percentage points from its 1970 level. As life expectancy increased, according to the paper’s model, then individuals had to save more for retirement, thus increasing the supply of savings. An increase in supply, all things being equal, will decrease the price of a loan—the interest rate. The second factor, also related to demographics, is the declining fertility rate in the United States as there are fewer births per woman. Fewer children reduces the demand for loans, which in turn depresses the interest rate. The three economists peg the influence of declining fertility at a 1.8 percentage point decline.

The third large factor behind declining rates is the decline in productivity growth. The rate of productivity increases have fallen significantly since the early 1970s, though there have been short periods of higher growth in the late 1990s. With slower productivity growth, households expect that income growth will be lower in the future (because their wages reflect that lack of productivity growth) and therefore save more. Again, an increase in the supply of savings leads to a decline in the interest rate: 1.9 percentage points in this case.

The one force increasing the interest rate over time in the model is the increase in government debt. More government debt, measured as a share of GDP, increases the interest rate as more government borrowing increases the demand for loans. The increase in demand is large enough that it pushed up the interest rate by a bit more than 2 percentage points since 1970.

Two other factors contribute to the changes in the natural rate: the declining labor share of income (a decline of 0.5 percentage points) and the declining price of capital goods (a decline of 0.4 percentage points).

Could any of these trends be reversed in the near future to boost interest rates? The authors look at how some of these factors would have to change in order to get the natural rate of interest up from roughly -1.5 percent to 1 percent, but those changes seem highly unlikely. Total factor productivity growth would have to accelerate from 2.4 percent despite the fact that sustained productivity growth of more than 2 percent hasn’t been seen since the 1970s. The fertility rate would have to jump by about 1.4 births per woman and the government debt would have to go from 118 percent of GDP to 215 percent.

In other words: Secular stagnation might be around for quite a time to come.

Should-Read: Thomas Black et al.: One Tiny Widget’s Dizzying Journey Shows Just How Critical Nafta Has Become

Should-Read: Thomas Black et al.: One Tiny Widget’s Dizzying Journey Shows Just How Critical Nafta Has Become: “Global trade involves a complex web of cross-border journeys, seamless and often invisible to American consumers…

…A single lowly capacitor, a pinkie tip-sized component that stores electrical energy…. We begin with a small Michigan company called Firstronic, which makes printed circuit boards for autoparts, such as automotive seat controls…. Firstronic… in Grand Rapids… buys the capacitor itself from… Centennial, Colorado… Arrow Electronics Inc., which imports the components from multiple suppliers in Asia. The capacitor is shipped to Ciudad Juárez, Mexico, where it is inserted into a circuit board. Then it heads to a U.S. warehouse just across the border…. The component then returns to Mexico, hauled to a Kongsberg Automotive factory in Matamoros. Kongsberg, a Norwegian company, assembles the circuit board into a seat actuator….

The control unit ships to… a Lear Corp. seat-manufacturing plant in Arlington, Texas…. Now traveling inside the finished seat, the capacitor is shipped a short distance to an auto assembly plant… the Ford Flex SUV at its factory in the Toronto suburb of Oakville…. The story of the little capacitor shows how intricately interconnected North American manufacturing operations have become…

Must- and Should-Reads: February 4, 2017


Interesting Reads:

Must-Read: Dan Nexon: The Trump Administration: It’s as Bad as it Looks

Must-Read: Dan Nexon: The Trump Administration: It’s as Bad as it Looks: “It will take about six minutes to watch Colin Kahl…

…former Deputy Assistant to the President and National Security Advisor to the Vice President, explain why:

Sean Spicer lied in his attempt to shift culpability onto the Obama Administration for the US raid in Yemen that killed an American serviceman and multiple civilians, as well as destroyed an MV-22 Osprey; and The conditions under which Trump authorized that raid—a dinner conversation with his son-in-law, the Defense Secretary, the Chairman of the Joint Chiefs of Staff, and a few others—was, shall we say, unusual for a major escalation in American military operations.

That six minutes is worth your time. There are real costs to having a President who is temperamentally, intellectually, and otherwise completely unqualified for his position. Those costs are magnified when his core advisors are total amateurs mainly interested in power, profit, or pushing extreme ideological agendas…

Must-Read: Jeff Engel: Robots Might Eat Your Job, But Being Human Could Get You A New One

Must-Read: But, unfortunately, teaching “creativity, empathy, teamwork, planning, problem solving, leadership, and so on” is very hard. And evaluating whether it is being successfully taught–whether the teaching of social engineering is any good–is even harder, in all likelihood because it may be easier to motivate the evaluators to give the teachers good scores than to motivate the students to learn…

Jeff Engel: Robots Might Eat Your Job, But Being Human Could Get You A New One: “Erik Brynjolfsson… ‘Will Robots Eat Your Job?’…

…The short answer is yes…. Automation has been transforming factories for years. But now, with advances in artificial intelligence technologies, automation is starting to also creep into fields that require less repetitive manual labor and perhaps seemed immune to this shift, such as law, healthcare, and journalism. “Machines are getting a lot better at many of these things,” Brynjolfsson said. “This a challenge we’re going to have to face, but I don’t think it’s a problem we have to face today…. There’s no shortage of work that can be done [only by humans] in the next 10 to 15 years.”… Educational institutions should focus instruction on areas where humans still have the advantage over machines. The examples he gave are mostly intangible characteristics and interpersonal skills: creativity, empathy, teamwork, planning, problem solving, leadership, and so on. “If we do that, I think we’ll have more people prepared to work alongside machines,” Brynjolfsson said. “Machines can help with a lot of that as well. There are educational technologies that can help identify the relative strengths and weaknesses of students and personalize things.”…

“We will get to a world where machines can do almost everything.” If handled in the right way, that “should be one of the best things that has happened to humanity”…. But it will require massive changes in how society operates… universal basic income or related programs so that people can sustain themselves. For now, Brynjolfsson wants to see leaders put more energy into solving more immediate issues, such as ensuring a skilled workforce and addressing stagnating wages…. “The most important thing we can do to address that is reinvent education and invest more in education.”

Should-Read: Sean Blanda: Medium, and The Reason You Can’t Stand the News Anymore

Should-Read: Sean Blanda: Medium, and The Reason You Can’t Stand the News Anymore: “We get sliced and sliced into smaller and smaller groups, each with its own group of pundits, publications, and Facebook memes…

…And as advertising mixes with propaganda mixes with actual reporting we can’t tell the difference anymore. It’s a never-ending scorched earth campaign, made possible because harming trust and encouraging tribalism is economically rewarded. In other words, the economic incentives of news directly contribute to the divisiveness of our country…. Facebook, Twitter, Google, and Medium ALSO have no economic incentive to solve these problems….

I know I’ll sound like some kind of pollyanna to suggest that if the American people demand more of their media outlets, advertisers, and social networks everything will work itself out. But I’d guess, regardless of your politics, you and everyone you know is tired of the current climate…. Tired of charlatans playing to the worse instincts of their tribe and getting rewarded…. Any solution is complicated and I have no illusions that it would happen in the next few years, if ever. But the first step is admitting we have a problem. Not one just one “side” or one outlet. But all players, news outlets, readers, advertisers, social media companies need to admit what we all know deep inside: Nobody is happy with this, and it’s time to try something new.

Should-Read: Pedro da Costa: Why the Trump Economic Boom Will Never Come

Should-Read: Pedro da Costa: Why the Trump Economic Boom Will Never Come: “Equity markets… [have] focused on Trump’s promises while ignoring his threats…

…But Trump has also shown he’s not likely to back away from his anti-trade agenda, which carries a high risk of retaliation from major trading partners like China and Mexico, and could devolve into a damaging all-out trade war…. Wall Street’s excitement over tax cuts is not tough to grasp—the rich stand to benefit overwhelmingly…. However, salivation over the prospect of a broader fiscal stimulus impact from Trump’s policy measures is likely misguided. If anything, the last two decades of economic policy have reaffirmed the failure of the sort of trickle-down economics that Trump and his advisors are espousing….

So far, Trump’s outlined proposals sound more like private sector giveaways of the sort that underpinned his deal with air-conditioner manufacturer Carrier in Indiana than any deeper program able to address the steep job losses experienced in many parts of the country that helped Trump win the election…. Then there’s the less tangible but potentially more important social impact of an ideology that contains strong elements of anti-immigrant, anti-Muslim, and anti-Semitic racism… not only anathema to American history but also widely seen as detrimental to economic growth….

Rich people will get tax cuts, and they own a lot of stock. So that’s good for the Dow, for now. But good luck to the investor trying to time the jump from that runaway train.

Should-Read: Larry Summers: A Telling Moment for Business Leaders

Should-Read: Business leaders are, in general, not the people to look to to take the lead in the public good operations of civil society at the nation state or the global level. They are enmeshed in networks of obligations. They thus respond to pressure that threatens the interests of those to whom they are obligated. But they do not take the lead that their take-charge within-the-firm personas would lead one to expect.

They can be–and very often are–powerfully influential and effective. But as a rule they are so only when their views and ideas are channeled through intermediary institutions with both funding and voice: the Republican Party, the Rubin wing of the Democratic Party, the Conference Board, the Business Roundtable, etc. It is the effective collapse of the first of these intermediary institutions as anything more than a lobby for tax cuts for the rich that is, I think, at the root of this Summers discontent. But while other forms of civil society mobilization produce crowds and argument in the streets, I think Summers will wait in vain for crowds and argument in the suites. That’s not how they do:

Larry Summers: A Telling Moment for Business Leaders: “I got a chance to spell out my views on the role of business leaders in influencing public policy…

…It is a complex issue given chief executives’ obligations to their shareholders, desire to be effective, fears of retaliation and much else. Just before the inauguration I expressed strongly the fear that American business leaders in Davos were legitimising the excessively problematic policy approaches of the new president, Donald Trump. Events since the inauguration have confirmed my fears. Policy has gone further than I expected in threatening an open global system and provoking key partners. It has undercut Statue of Liberty values and the rule of law more than I anticipated. Especially in foreign policy, words are deeds. It takes decades for a nation to build credibility and trust that can be sacrificed in a matter of hours. There are signs that quite a few business leaders are waking up to the dangers to their companies inherent in current trends. So maybe the business community, whose approval the administration craves, will start to pressure the administration rather than simply cheering on tax cuts and deregulation.

The Friday meeting of corporate leaders and the president will be very revealing. Will the group let themselves be used to legitimise policy trends? Will they focus on near-term parochial regulatory and tax issues? Or, as I hope, will they express real concern about the long-term impact if the US continues to embrace protectionism, undercut European integration, challenge China over Taiwan and prevent Muslims from entering the country? For those who argue that business should focus on the long-term and stress how closely American economic and business success are related, this will be a telling moment.

Should-Read: Joe Coscarelli: The ‘Bowling Green Massacre’

Should-Read: That this mistake could have been made is already a huge problem:

Joe Coscarelli: The ‘Bowling Green Massacre’: “Kellyanne Conway, the adviser to President Trump who coined the phrase ‘alternative facts’…

…falsely spoke of a “Bowling Green massacre” by Iraqi refugees… during an appearance on MSNBC’s “Hardball” on Thursday night as she discussed with the host, Chris Matthews, the executive order by Mr. Trump that suspended immigration from seven Muslim-majority countries: “I bet it’s brand new information to people that President Obama had a six-month ban on the Iraqi refugee program after two Iraqis came here to this country, were radicalized and were the masterminds behind the Bowling Green massacre. Most people don’t know that because it didn’t get covered.” In fact, no “Bowling Green massacre” ever happened…. Not long after Ms. Conway’s comments were debunked Thursday night, a clip of her interview went viral online, leading to ridicule and some humorous suggestions as to what she could have been referring to (namely, sports)….

On Friday morning, Ms. Conway admitted she had made an error: “Honest mistakes abound,” she wrote…. As for her overshadowed assertion that President Obama had instituted a six-month ban on the Iraqi refugee program after the Bowling Green arrests, that’s not quite true either: While the Obama administration slowed the visa process, some Iraqi refugees were admitted to the United States in every month of 2011. Ms. Conway did clarify that, yes, she had been referring to the case of Mr. Hammadi and Mr. Alwan. Yet, by pointing to an ABC News article from November 2013, she undermined her claim that the story “didn’t get covered.” It did.