Reflections on Secular Stagnation

Dr. Lawrence H. Summers

February 19, 2015

Outline

I. Problematic post-crisis economic performance in the industrial world

II. The secular stagnation hypothesis

III. Why have real interest rates fallen?

IV. Issues raised by secular stagnation hypothesis?

V. What is to be done?

2

Downward Revision in Potential GDP, USA

Sources: Congressional Budget Office, Bureau of Economic Analysis 3

8

8.5

9

9.5

10

10.5

11

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Trill

ions

of

2005

Eur

os

Eurozone Actual and Potential GDP

Actual

2008

YearEstimated:

Potential GDP Estimates

2010 2012

2014

Downward Revision in Potential GDP, Eurozone

Sources: IMF World Economic Outlook Databases, Bloomberg 4

50

1983 1988 1993 1998 2003 2008 2013

2000 2005 2010 20 15

100

150

Japan Actual

Euro Actual

14% BelowExpectation

13% BelowExpectation

100=

1991

(Jap

an)

and

2007

(Eur

o A

rea)

(Log

Sca

le)

Japan and Euro Area, Forecast Versus Reality

Europe Mirrors Japan’s Experience

Sources: OECD 1992 “Long Term Prospects For The World Economy”, IMF 2007, 2007 & 2014 WEO Database 5

Falling Potential A Global Phenomenon

Sources: Laurence Ball “Long-Term Damage From The Great Recession in OECD Economies”, IMF WEO 2008 & 2014 6

Change in 2013 Potential Output Estimate Since 2007

-20 +6

Recent U.S. Business Cycles Financially Unsustainable

7 Sources: Federal Reserve, Bureau of Economic Analysis

European Credit Boom

8 Sources: World Bank, Bloomberg

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

US TIPS Yield Curve

2008 - Jan

2015 - Jan

Real Yield Curve Before and After Crisis

9 Sources: Federal Reserve Refet S. Gürkaynak, Brian Sack, and Jonathan H. Wright, Bloomberg

Expected Rates Have Plunged

10 Sources: Federal Reserve Refet S. Gürkaynak, Brian Sack, and Jonathan H. Wright, Bloomberg (End of January 2015 vs. 2014)

Rate Five Year/Five Years Forward

Now Year Ago

Nominal 2.3 4.2

Inflation 1.8 2.5

Real 0.6 1.7

“Secular Stagnation” Dates To The 1930s

11

“This is the essence of secular stagnation - sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.” - Alvin Hansen, 1939

Sources: Alvin Hansen “Economic Progress and Declining Population Growth”, American Economic Review, March 1939

Liquidity Trap Framework

12

Possible Savings/Investment Curves

13

Private Investment Shortfall

Sources: IMF 2014 WEO Database

18

20

22

24

26

28

30

2000 2002 2004 2006 2008 2010 2012

Pe

rce

nt o

f GD

P

Eurozone

16

20

24

28

2000 2002 2004 2006 2008 2010 2012

Pe

rce

nt o

f GD

P

USA

16

20

24

28

32

36

40

2000 2002 2004 2006 2008 2010 2012

Pe

rce

nt o

f GD

P

Japan

14

-1

0

1

2

3

4

5

1985 1990 1995 2000 2005 2010

Real

Inte

rest

Rat

e

World Real Interest Rate

World Rates Have Fallen Steadily

Sources: Mervyn King “Measuring the World Real Interest Rate” 15

As Have U.S. TIPS

Sources: Bloomberg 16

Large Rate Cuts Are Common

Sources: Brad DeLong, Federal Reserve 17

0.7%0.7%

0.6%

0.1%

-0.1%

-0.2%-0.3%

-0.2%

-0.1%

-0.4%

0.0%

0.4%

0.8%

1995-2000 2000-2005 2005-2010 2010-2015 2015-2020 2020-2025 2025-2030 2030-2035 2035-2040

Cont

ribu

tion

By

Reg

ion

(At

Ann

ual

Rat

e)

Advanced Economy Change in Working Age Population

Europe

Asia(Japan, Korea,

Hong Kong, Singapore,

& Australia)

US & Canada

Demographics Challenging

Sources: United Nations Population Division, IMF 18

75

80

85

90

95

100

105

110

115

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

100=

1947

Relative Price of Fixed Investment vs GDP

Capital Investment Has Gotten Cheaper

Sources: Bureau of Economic Analysis 19

Corporations Have Less Investment Needs

Sources: Fortune Magazine, Company Financial Reports 20

0%

4%

8%

12%

16%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Perc

ent o

f G

loba

l G

DP

World Foreign Exchange Reserves

Emerging Economies

Advanced Economies

Rising Reserve Accumulation

Sources: International Monetary Fund’s COFER Database, IMF 21

Increased Demand For Safe Assets

22 Sources: Treasury Borrowing Advisory Committee 2013 Q2 Discussion Charts, p.60

0

5

10

15

20

25

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003

Perc

ent o

f To

tal

Inco

me

Income Share of Top 1%

Rising Inequality

Sources: World Top Incomes Database 23

0%

2%

4%

6%

8%

10%

12%

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Perc

ent o

f G

DP

After Tax Profits and Retained Earnings

Profits After Tax

Retained Earnings

And Rising Corporate Profit Share

Sources: Bureau of Economic Analysis 24

Lower Inflation and Tax Effects

• Consider investor in 40% tax bracket

• Pre-Tax Real Rate = i –π

• Post-Tax Real Rate = (i) (1-τ)- π

25

Rising Financial Intermediation Cost

26 Sources IMF October 2014 Global Financial Stability Report

Issues Raised By The Secular Stagnation Hypothesis

• Can equilibrium real interest rates really be subzero?

• Is the issue on the supply or demand side?

• Past fears of secular stagnation proved unfounded

• Isn’t the United States approaching full employment?

27

Inflation Expectations

28 Sources: Bloomberg

Large Rate Cuts Are Common

Sources: Brad DeLong, Federal Reserve 29

Alternative Strategies

• Structural Reform

• Reduce Real Rates

• Increase Spending

30

Monetary Policy

• How much scope at liquidity trap?

• More effective in conjunction with other measures

• Risks of bubbles and financial instability

• Backward bending supply of saving?

• Need for international coordination

31

Focus On Structural Reform

• Has been tried for years

• Risk of destabilizing deflation

• Inverse Say’s Law – Lack of demand reduces potential supply

• Political economy issues

• Increased competitiveness is a zero sum game

32

Focus On Increases In Spending

• Operates to raise equilibrium real interest rates

• Rational response to low real borrowing costs

• Major public investment gaps

• Investments likely to reduce debt burdens

• Remove barriers to private investment

• Measures to promote consumption and housing investment

• Measures to promote external adjustment in surplus countries

33

Infrastructure Investment Can Boost GDP 3 For 1

Sources: IMF October 2014 World Economic Outlook Ch.3 “The Macroeconomic Effects of Public Investment” 34

While Making Debt More Sustainable

Sources: IMF October 2014 World Economic Outlook Ch.3 “The Macroeconomic Effects of Public Investment” 35

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

1971 1976 1981 1986 1991 1996 2001 2006 2011

Pe

rce

nt o

f G

DP

Net Public Investment

USA

Eurozone

But Has Been Hit By Austerity

Sources: US Bureau of Economic Analysis, Eurozone AMECO database 36

Other Possible Responses

• Public equity investments

• Work sharing

• Population and immigration policies

37