Thinking About Ken Rogoff: Overleverage, Secular Stagnation, Savings Glut, Impaired Financial Trust
Ken Rogoff–of whom my standard line is: everything he says is very interesting, and almost everything he says is completely correct–is weighing in: on secular stagnation, the global savings glut, the safe-asset shortage, the balance-sheet recession, whatever you want to call it.
His view is that excessive debt issue and overleverage are at the roots of most of our problems. He thus believes that our difficulties will end when deleverage has reduced the overhang of risky and underwater debt to a sustainable level:
…After deleveraging and borrowing headwinds subside, expected growth trends might prove higher…. The US and perhaps the UK have reached the end of the deleveraging cycle…. The evidence in favour of the debt supercycle view…. The lead up to and aftermath of the 2008 global financial crisis has unfolded like a garden variety post-WWII financial crisis… the magnitude of the housing boom and bust, the huge leverage… the behaviour of equity prices… and certainly the fact that rises in unemployment were far more persistent than after an ordinary recession…. Even the dramatic rises in public debt that occurred after the Crisis are quite characteristic….
Modern macroeconomics has been slow to get to grips with the analytics of how to incorporate debt supercycles…. There has been far too much focus on orthodox policy responses and not enough on heterodox responses that might have been better suited to a crisis greatly amplified by financial market breakdown…. Policymakers should have more vigorously pursued debt write-downs… bank restructuring and recapitalisation…. Central banks were too rigid with their inflation target regimes…. Fiscal policy (one of the instruments of the orthodox response) was initially very helpful in avoiding the worst of the Crisis, but then many countries tightened prematurely….
The debt supercycle model matches up with a couple of hundred years of experience…. The secular stagnation view does not capture the heart attack…. Secular stagnation proponents… argue that only a chronic demand deficiency could be responsible for steadily driving down the global real interest rate…. 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…. 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….
What are the policy differences between the debt supercycle and secular stagnation view? When it comes to government spending that productively and efficiently enhances future growth, the differences are not first order. With low real interest rates, and large numbers of unemployed (or underemployed) construction workers, good infrastructure projects should offer a much higher rate of return than usual…
I think that this last point is crucial. We have underemployment. We have interest rates on government debt and thus the debt amortization costs of the government far below any plausible rate of return on productive public investments (or, indeed, any plausible social rate of time discount geared to a sensible degree of risk aversion and the trend rate of technological progress). Under such circustances, at least reserve currency-issuing governments with exorbitant privilege should certainly be spending more, taxing less, and borrowing.
There are, however, long-run issues in which the policies recommended by the different diagnoses differ.
- A Minskyite temporary crisis of overleverage and of excessive underwater debt requires debt writedowns and financial-intermediary recapitalizations.
- A Bernanke-Gertler temporary crisis of impaired capital and trust clogging the credit channel requires the building of new financial intermediary institutions with a proper level of capital and with a regulatory structure that promotes trust–and requires extra levels of both regulation and loan guarantees while that trust is rebuilt.
- A Summers secular-stagnation chronic crisis of insufficiently-profitable risk-adjusted investment opportunities requires a shift in responsibility for long-run expenditure from private to government.
- A Bernanke global savings-glut chronic crisis requires shifts in global governnance that reduce incentives to run large trade surpluses and a redistribution of world income to those with lower marginal propensities to save.
And, of course, these four diagnoses overlap–in the long run policies to deal with each chronic crisis configuration overlap as well.
Paul Krugman takes aim at this part of Rogoff’s piece:
…Overly optimistic forecasts played a central role in every aspect of most countries’ responses to the crisis. No one organisation was to blame, as virtually every major central bank, finance ministry, and international financial organisation was repeatedly overoptimistic. Most private and public forecasters anticipated that once a recovery began it would be V-shaped, even if somewhat delayed. In fact, the recovery took the form of the very slow U-shaped recovery predicted by scholars who had studied past financial crises and debt supercycles. The notion that the forecasting mistakes were mostly due to misunderstanding fiscal multipliers is thin indeed. The timing and strength of both the US and UK recoveries defied the predictions of polemicists who insisted that very slow and gradual normalisation of fiscal policy was inconsistent with recovery….
…that we”re suffering from a painful but temporary era of deleveraging, and that normal policy will resume in a few years…. Rogoff doesn”t address the key point that Larry Summers and others, myself included, have made–that even during the era of rapid credit expansion, the economy wasn’t in an inflationary boom and real interest rates were low and trending downward–suggesting that we”re turning into an economy that “needs” bubbles to achieve anything like full employment. But what I really want to do right now is note… people who predicted soaring interest rates from crowding out right away now claim that they were only talking about long-term solvency… people who issued dire warnings about runaway inflation say that they were only suggesting a risk, or maybe talking about financial stability; and so on down the line…. In Rogoff’s version of austerity fever all that was really going on was that policymakers were excessively optimistic, counting on a V-shaped recovery; all would have been well if they had read their Reinhart-Rogoff on slow recoveries following financial crises. Sorry, but no….
David Cameron didn’t say “Hey, we think recovery is well in hand, so it’s time to start a modest program of fiscal consolidation.” He said “Greece stands as a warning of what happens to countries that lose their credibility.” Jean-Claude Trichet didn’t say “Yes, we understand that fiscal consolidation is negative, but we believe that by the time it bites economies will be nearing full employment”. He said: “As regards the economy, the idea that austerity measures could trigger stagnation is incorrect … confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.” I can understand why a lot of people would like to pretend, perhaps even to themselves, that they didn’t think and say the things they thought and said. But they did.
And this part of Ken Rogoff’s piece appears to me to be on the wrong track:
small changes in the market perception of tail risks can lead both to significantly lower real risk-free interest rates and a higher equity premium…. Martin Weitzman has espoused a different variant of the same idea based on how people form Bayesian assessments of the risk of extreme events…. Those who would argue that even a very mediocre project is worth doing when interest rates are low have a much tougher case to make. It is highly superficial and dangerous to argue that debt is basically free. To the extent that low interest rates result from fear of tail risks a la Barro-Weitzman, one has to assume that the government is not itself exposed to the kinds of risks the market is worried about, especially if overall economy-wide debt and pension obligations are near or at historic highs already. Obstfeld (2013) has argued cogently that governments in countries with large financial sectors need to have an ample cushion, as otherwise government borrowing might become very expensive in precisely the states of nature where the private sector has problems…
But more on this later…