Harvard’s Larry H. Summers on Secular Stagnation – IMF F&D
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Bibliographic details
- Authors: LAWRENCE H SUMMERS
- Published: March 1, 2020
Overview
- Author: LAWRENCE H. SUMMERS, Charles W. Eliot University Professor at Harvard University and a former US Treasury secretary.
- Publication: F&D Magazine, March 2020.
- Thesis: Current macroeconomic theories premised on monetary policy’s ability to determine inflation may be unsuited to present realities; a “new old Keynesian economics” built on Alvin Hansen’s idea of secular stagnation is needed to explain sluggish growth, low interest rates, and an absence of inflation, and to guide policy responses.
The investment dearth
- Demographics and labor force:
- The industrial world’s working-age population will decline over the next generation.
- China’s working-age population will decline as well.
- Trends toward increased labor force participation of women have played out (example: more women than men now working in the United States).
- Reduced demand for capital goods:
- Declining need for new capital to equip and house a growing workforce.
- The amount of saving required to purchase a given amount of capital goods has declined sharply as the relative price of equipment, especially in the information technology (IT) space, has sharply declined.
- Example: A $500 iPhone today has more computing power than a Cray supercomputer did a generation ago.
- Lower prices of capital goods encourage delaying investment.
- Sectoral and technological shifts reducing investment demand:
- E-commerce reduced demand for shopping malls.
- The cloud reduced demand for office space.
- Fracking requires far less capital than traditional drilling techniques.
- Sharing economy examples: apartments (Airbnb), planes (NetJets), dresses (Rent the Runway), cars (Uber).
- Rising generations favor sparsely furnished apartments rather than large homes.
- Institutional and policy frictions:
- Increased monopoly power (at least in the United States) tends to discourage new investment.
- Increased distribution of veto power has slowed public infrastructure investment; on a net basis public infrastructure investment in the United States is running at less than half of previous levels.
- Net result: Investment demand has been substantially reduced, regardless of interest rate levels.
The savings glut
- Factors increasing saving:
- A larger amount of income is accruing to higher-income people who have a greater propensity to save.
- Increased corporate profitability, coupled with lower interest rates, means more corporate retained earnings.
- Increases in uncertainty (doubts about government’s ability to meet pension obligations, more risk of future tax increases) raise saving.
- Reductions in expected future income growth increase the need for future saving.
- Strengthened financial regulation and its legacy make households find it more difficult to borrow and spend, increasing aggregate saving (examples: higher down payment requirements reducing mortgage borrowing; higher capital requirements on financial intermediaries).
- Net result: Structural changes have operated both to raise saving and to reduce investment.
Secular stagnation: observable implications and evidence
- Definition: Alvin Hansen’s label for the failure of private investment to fully absorb private savings, threatening insufficient demand.
- Empirical expectations and observations:
- Low demand and high supply of savings imply low interest rates. Observation: real rates by almost any measure have been trending downward over the last 20 years, even as budget deficits have increased; real-term interest rates have been negative in the industrial world despite major run-ups in government debt.
- Difficulty absorbing savings leads to reduced growth and difficulty achieving target inflation. Observation: markets do not expect any country in the industrial world to hit a 2 percent inflation target; despite unprecedentedly low interest rates and deficits at record levels after more than a decade of recovery, growth has been tepid.
- Stagnation coincides with inflation surprising on the downside. If disappointing productivity were dominant, prices would be expected to rise rather than fall; absent extraordinary policy settings, deflation might be setting in.
- Slow growth and deflation have coincided with asset price inflation. Observation: US stock markets have risen fourfold since the crisis, and real housing prices are almost back to previous peak levels—consistent with abundant savings pushed into existing assets, increasing price-to-earnings ratios on stocks and price-to-rent ratios on real estate and decreasing term premiums on long debt.
- Rejection of alternative explanations:
- Lack of productivity growth would be expected to produce increased product price inflation and reduced asset price inflation—contrary to observations.
- Increased risk and uncertainty would tend to lead to decreased rather than increased asset price multiples.
- Any temporary consequence of the financial crisis would lead to reduced credit expansion and a steep yield curve rather than what has been observed.
Policy implications and recommendations
- Reassess macroeconomic frameworks:
- Recognize and accept the reality of secular stagnation as the starting point for policy debates.
- Develop what Summers terms a “new old Keynesian economics” to address current structural conditions.
- Monetary policy priorities:
- Central banks, to be true to their mandates, need to raise rather than lower inflation.
- Central banks are unlikely—rates already negative in Japan and Europe and below 2 percent in the United States—to have much room, at least by historical standards, to respond to adverse shocks.
- Historical context: recessions in the industrial world have typically been addressed by decreases in rates on the order of 5 percentage points.
- Fiscal and structural priorities:
- Ensuring economies fulfill their potential is a challenge that logically precedes increasing their potential.
- The medium-term issue is the full absorption of savings rather than the crowding-out of investment.
- Financial stability is as much at risk from low rates as from high rates.
- Broader focus:
- Policy debates should focus on the challenges posed by abundant savings and reduced investment demand stemming from demographic, technological, and institutional changes.
Source: F&D Magazine article “Accepting the Reality of Secular Stagnation” by LAWRENCE H. SUMMERS, March 2020.
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