Tag: Lawrence Summers

Sluggish Future: No Longer Fresh Over at Finance and Development

Posted on by Brad DeLong
Secular Stagnation

Over at Finance and Development: Sluggish Future: You are reading this because of the long, steady decline in nominal and real interest rates on all kinds of safe investments, such as US Treasury securities. The decline has created a world in which, as economist Alvin Hansen put it when he saw a similar situation in 1938, we see “sick recoveries… die in their infancy and depressions… feed on themselves and leave a hard and seemingly immovable core of unemployment…” In other words, a world of secular stagnation. Harvard Professor Kenneth Rogoff thinks this is a passing phase—that nobody will talk about secular stagnation in nine years. Perhaps. But the balance of probabilities is the other way. Financial markets do not expect this problem to go away for at least a generation… Read MOAR at Finance and Development

My Draft: You are reading this right now because of the long, steady decline in safe interest rates at all maturities since 1990.(1)

In the United States, we have seen declines in short-term safe interest rates from 4% to -1.2% on the real side and from 8% to 0.5% on the nominal side. And we have seen the decline in long-term safe interest rates from 5% to 1% on the real side, and from 9% to 3% on the nominal side. The elusive Wicksellian “neutral” rate of interest—that rate at which planned investment equals desired full-employment savings—has fallen by more: the economy in 1990 had no pronounced tendency to fall short of full employment; the economy today has.

An economy suffers from “secular stagnation” when the average level of safe nominal interest rates is low and so crashes the economy into the zero lower bound with frequency. Thus, in the words of Alvin Hansen (1939): “sick recoveries… die in their infancy and depressions… feed on themselves and leave a hard and seemingly immovable core of unemployment…”(2)

Financial markets, at least, do not expect this problem to go away for at least as generation. That makes, as I have written, this current policy debate “the most important policy-relevant debate in economics since John Maynard Keynes’s debate with himself in the 1930s…”

I have heard eight different possible causes advanced for this secular fall in safe interest rates:

  1. High income inequality, which boosts savings too much because the rich can’t think of other things they’d rather do with their money.
  2. Technological and demographic stagnation that lowers the return on investment and pushes desired investment spending down too far.
  3. Non-market actors whose strong demand for safe, liquid assets is driven not by assessments of market risk and return but rather by political factors or by political risk.
  4. A collapse or risk-bearing capacity as a broken financial sector finds itself overleveraged and failing to mobilize savings, thus driving a large wedge between the returns on risky investments and the returns on safe government debt.
  5. Very low actual and expected inflation, which means that even a zero safe nominal rate of interest is too high to balance desired investment and planned savings at full employment.
  6. Limits on the demand for investment goods coupled with rapid declines in the prices of those goods, which together put too much downward pressure on the potential profitability of the investment-goods sector.
  7. Technological inappropriateness, in which markets cannot figure out how to properly reward those who invest in new technologies even when the technologies have enormous social returns—which in turn lowers the private rate of return on investment and pushes desired investment spending down too far.
  8. Increased technology- and rent seeking-driven obstacles to competition which make investment unprofitable for entrants and market-cannibalizing for incumbents.

The first of these was John A. Hobson’s explanation a century ago for the economic distress that had led to the rise of imperialism.(3) The second was, of course, Hansen’s, echoed today by Robert Gordon.(4) The third is Ben Bernanke’s global savings glut.(5) The fourth is Ken Rogoff’s debt-supercycle.(6)

The fifth notes that, while safe real interest rates are higher than they were in the 1980s and 1990s, that is not the case for the 1960s and 1970s. It thus attributes the problem to central banks’ inability to generate the boost from expected and actual inflation a full-employment flex-price economy would generate naturally.(7)

(6), (7), and (8) have always seemed to me to be equally plausible as potential additional factors. But the lack of communication between industrial organization and monetary economics has deprived them of scrutiny. While Gordon, Bernanke, Rogoff, Krugman, and many others have covered (1) through (5), (6), (7), and (8) remain undertheorized.

In general, economists have focused on a single individual one of these causes, and either advocated policies to cure it at its roots or waiting until the evolution of the market and the polity removes it. By contrast, Lawrence Summers(8) has focused on the common outcome. And if one seeks not to cure a single root cause but rather to neutralize and palliate the deleterious macroeconomic effects of a number of causes working together, one is driven—as Larry has been—back to John Maynard Keynes (1936)(9):

A somewhat comprehensive socialisation of investment… [seems] the only means of securing an approximation to full employment… not exclud[ing] all manner of compromises and of devices by which public authority will cooperate with private initiative…

Summers has, I think, a very strong case here. Ken Rogoff likes to say that nine years from now nobody will be talking about secular stagnation.

Perhaps.

But if that is so, it will most likely be so because we will have done something about it.

 

Notes:

(1) For considerably overlapping and much extended versions of this argument, see J. Bradford DeLong (2016): Three, Four… Many Secular Stagnations! http://www.bradford-delong.com/2017/01/three-four-many-secular-stagnations.html; (2015): The Scary Debate Over Secular Stagnation: Hiccup… or Endgame? Milken Review http://tinyurl.com/dl20170106m

(2) Alvin Hansen (1939): Economic Progress and Declining Population Growth American Economic Review https://www.jstor.org/stable/1806983

(3) John A. Hobson (1902): Imperialism: A Study (New York: James Pott) http://files.libertyfund.org/files/127/0052_Bk.pdf

(4) Robert Gordon (2016): The Rise and Fall of American Growth http://amzn.to/2iVbYKm

(5) Ben Bernanke (2005): The Global Saving Glut and the U.S. Current Account Deficit http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/

(6) Kenneth Rogoff (2015): Debt Supercycle, Not Secular Stagnation http://www.voxeu.org/article/debt-supercycle-not-secular-stagnation

(7) Paul Krugman (1998): The Return of Depression Economics http://tinyurl.com/dl20170106r

(8) Lawrence Summers (2013): Secular Stagnation http://larrysummers.com/imf-fourteenth-annual-research-conference-in-honor-of-stanley-fischer/ ; https://www.youtube.com/watch?v=KYpVzBbQIX0&ab_channel=JamesDecker; (2014): U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound http://link.springer.com/article/10.1057%2Fbe.2014.13; (2015): Rethinking Secular Stagnation After Seventeen Months http://larrysummers.com/wp-content/uploads/2015/07/IMF_Rethinking-Macro_Down-in-the-Trenches-April-20151.pdf;(2016): The Age of Secular Stagnation http://larrysummers.com/2016/02/17/the-age-of-secular-stagnation/

(9) John Maynard Keynes (1936): The General Theory of Employment, Interest and Money https://www.marxists.org/reference/subject/economics/keynes/general-theory/ch24.htm

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Must-read: Olivier Blanchard et al.: “Inflation and Activity–Two Explorations and their Monetary Policy Implications”

Posted on by Brad DeLong

Must-Read: Olivier Blanchard, Eugenio Cerutti, and Lawrence Summers: Inflation and Activity–Two Explorations and their Monetary Policy Implications: “Since the mid-1970s, short-run inflation expectations have become more stable…

…(λ has increased), and… the slope of the Phillips curve (θ) has flattened over time, with nearly all of the decline taking place from the mid-1970s to the early 1990s…. For most countries, the coefficient θ today is not only small, but also statistically insignificant…

Https www imf org external pubs ft wp 2015 wp15230 pdf

Must-Read: Larry Summers: Central Bankers Do Not Have as Many Tools as They Think

Posted on by Brad DeLong

Must-Read: As John Maynard Keynes famously wrote, a government dedicated to producing a high-pressure economy is needed to enable entrepreneurship, enterprise, and growth. A government that does not only fail to work to generate high-pressure now, but also lacks a plan for fighting the next recession, is a government that drives the Confidence Fairy far away indeed:

Lawrence Summers: Central Bankers do Not Have as Many Tools as They Think: “It is agreed that the ‘neutral’ interest rate…

…has declined substantially and is likely to be lower in the future than in the past throughout the industrial world because of a growing relative abundance of savings relative to investment…. Neutral real interest rates may well rise over the next few years…. This is what many expect…. [But a] number of considerations make me doubt the US economy’s capacity to absorb significant increases in real rates over the next few years… leav[ing] me far from confident that there is substantial scope for tightening in the US and there is probably even less scope in other parts of the industrialised world. The fact that central banks in countries, including Europe, Sweden and Israel, where rates were zero found themselves reversing course after raising rates adds to the cause for concern.

But there is a more profound worry…. Once a recovery is mature the odds of it ending within two years are about half…. When recession comes it is necessary to cut rates more than 300 basis points. I agree with the market that the odds are the Fed will not be able to raise rates 100 basis points a year without threatening to undermine recovery…. [Thus] the chances are very high that recession will come before there is room to cut rates enough to offset it. The knowledge that this is the case must surely reduce confidence….

The unresolved question that will hang over the economy is how policy can delay and ultimately contain the next recession. It demands urgent attention from fiscal as well as monetary policymakers.

The Keynes quote, from the General Theory:

If effective demand is deficient… the individual enterpriser who seeks to bring… resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros…. Hitherto the increment to the world’s wealth has fallen short of the aggregate of positive individual savings; and the different eras been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual goo fortune. But if effective demand is adequate, average skill and average good fortune will be enough….

It is certain that the world will not much longer tolerate the unemployment which, apart from brief intervals of excitement, is associated… with present-day capitalistic individualism. But it may be possible by a right analysis of the problem to cure the disease while preserving efficiency and freedom…

Secular Stagnation–That’s My Title, of the Longer Version at Least

Posted on by Brad DeLong

J. Bradford DeLong: The Tragedy of Ben Bernanke: Project Syndicate:

Ben Bernanke has published his memoir, The Courage to Act.

I am finding it hard to read. And I am finding it hard to read as anything other than a tragedy. It is the story of a man who may have been the best-prepared person in the world for the job he was given, but who soon found himself outmatched by its challenges, quickly falling behind the curve and never quite managing to catch up.

It is to Bernanke’s great credit that the shock of 2007-2008 did not trigger another Great Depression. But the aftermath was unexpectedly disappointing… READ MOAR AT PROJECT SYNDICATE

Must-Read: Joseph E. Gagnon: Is QE Bad for Business Investment? No Way!

Posted on by Brad DeLong

Must-Read: Also Larry Summers.

The important thing here, I think, is to have Bernanke’s back. Bernanke is right: QE was worth trying ex ante, and ex post it looks as though it was worth doing–and I would say it was worth doing more of it than he did. If there are arguments that Bernanke’s QE policy is wrong, they need to be arguments–not mere expressive word-salad.

Spence and Warsh are attacking Bernanke’s monetary policy. Why? It’s not clear–they claim that business investment is low because Bernanke’s QE policies have retarded it. But they do not present anything that I would count as an argument or evidence to that effect. As I see it, they are supplying a demand coming from Republican political masters, who decided that since Obama renominated Bernanke the fact that Bernanke was a Republican following sensible Republican policies was neither here nor there: that they had to oppose him–DEBAUCHING THE CURRENCY!!

And Warsh and Spence are meeting that demand, and meeting it when a more sensible Republican Party–and more sensible Republican economists–would be taking victory laps on how the George W. Bush-appointed Republican Fed Chair Ben Bernanke produced the best recovery in the North Atlantic.

I don’t know why Warsh is in this business, lining up with the Randites against Bernanke, other than hoping for future high federal office. And I am with Krugman on Spence: I have no idea why Spence is lining up with Warsh here–he is very sharp, even if he did give me one of my two B+s ever. What’s the model?

Joseph E. Gagnon: Is QE Bad for Business Investment? No Way!: “There is no logical or factual basis for their claim…

…It is the reluctance of businesses and consumers to spend in the wake of a historic recession that is forcing the Fed and other central banks around the world to keep interest rates unusually low–not the other way around…. Economies in which central banks were most aggressive in conducting QE early in the recovery (the United Kingdom and the United States) have been growing more strongly than economies that were slow to adopt QE (the euro area and Japan). At the top of their piece, the authors pull a classic bait and switch, noting ‘gross private investment’ has grown slightly less than GDP since late 2007. Yet the shortfall in private investment derives entirely from housing. No one believes that Fed purchases of mortgage bonds tanked the housing market. The whole premise of the article, that business investment is excessively weak, is simply false….

But the piece also fails a basic test of common sense. Spence and Warsh posit that ‘QE has redirected capital from the real domestic economy to financial assets at home and abroad.’ This statement reveals a fundamental misunderstanding of what financial assets are. They are claims on real assets. It is not possible to redirect capital from financial assets to real assets, since the two always are matched perfectly. Equities and bonds are (financial) claims on the future earnings of (real) businesses. Spence and Warsh accept that QE raised the prices of equities and bonds. Yet they seem ignorant of the effect this has on incentives to invest…. True, some businesses have used rising profits to buy back their own stock. But that is a business prerogative that points to lackluster investment prospects and cannot be laid at the feet of easy Fed policy…. [If] QE has raised stock prices, it discourages businesses from buying back stock because it makes that stock more costly to buy…

Must-Read: Lawrence Summers: Global Economy: The Case for Expansion

Posted on by Brad DeLong

Must-Read: Uncertainty about what the correct model of the economy is and a strongly asymmetric loss function do not simply apply to the question of whether the Federal Reserve should start a tightening cycle now or delay for a year and reevaluate then. It also applies to the question of whether fiscal policy–with its substance-free love of austerity–is fundamentally, tragically, and potentially catastrophically misguided:

Lawrence Summers: Global Economy: The Case for Expansion: “The inability of the industrial world to grow at satisfactory rates even with very loose monetary policies…

…problems in most big emerging markets, starting with China… the spectre of a vicious global cycle…. The risk of deflation is higher than that of inflation… we cannot rely on the self-restoring features of market economies… hysteresis–where recessions are not just costly but stunt the growth of future output–appear far stronger…. Bond markets… are [saying:] risks tilt heavily towards inflation… below… targets… [despite expected] monetary policy… looser than the Federal Reserve expects… [plus] extraordinarily low real interest rates….

If I am wrong about [the need for] expansionary fiscal policy, the risks are that inflation will accelerate too rapidly, economies will overheat and too much capital will flow to developing countries. These outcomes seem remote. But even if they materialise, standard approaches can be used to combat them. If I am right and policy proceeds along the current path, the risk is that the global economy will fall into a trap not unlike the one Japan has been in for 25 years…. What is conventionally regarded as imprudent offers the only prudent way forward.

If the world undertook a large, coordinated fiscal expansion, five years from now we might regret it: we might be trying to reduce an uncomfortably-high inflation rate via tight monetary policy and relatively-high interest rates, and worrying about the long-term sustainability of government debt given that, finally, r>g. But those are problems we can handle, and those are problems of a world near full employment with ample incentives to invest in physical capital, organizational business models, and new technology.

If the world does not undertake a large, coordinated fiscal expansion, five years from now we might regret it: having failed to do anything to claw the global economy off the lee shore of the zero lower bound in 2015-6, the next adverse shock would leave the world mired in a depression as deep as 2008-9 with no available monetary policy tools to fight it.

In a world of uncertainty about the right model, the correct policy choice is obvious.

Yet the center of the Fed–both FOMC participants and staff alike–say things like: “You cannot make policy without a forecast.” And they go on to say that they will take the next policy step as if the forecast is accurate, and reevaluate only as outcomes differ from expectations. This seems to me to be an elementary mistake: in finance, after all, those who neglect optionality get taken to the cleaners by those who see it and use it.

And it is not as if the Federal Reserve’s current forecast–for rising PCE inflation crossing 2%/year in less than two years–even looks to me like the right forecast: is this a pattern that you think will generate wage growth high enough to sustain 2%/year-plus PCE inflation in two years?

A kink in the Phillips curve Equitable Growth

Morning Must-Watch: Lawrence Summers:

Posted on by Brad DeLong

Owen Zidar Weekend Links: “Larry Summers gave a talk at INET (starts at 45 min and goes to 1:38 or so)…

…with some especially interesting hypotheses about the changing structure of investment (from GE’s high capital investment model to Google’s abundance of cash) and reflections on the agriculture transition (around 1:21) and the associated difficulties with large shifts in the industrial composition of employment… http://new.livestream.com/INETeconomics/HumanAfterAll/videos/47888551