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
Trillions of 2005 Euros Downward Revision in Potential GDP, Eurozone 11 Eurozone Actual and Potential GDP Year Estimated: 10.5 Potential GDP Estimates 2008 10 9.5 2010 2012 2014 9 8.5 Actual 8 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sources: IMF World Economic Outlook Databases, Bloomberg 4
100=1991 (Japan) and 2007 (Euro Area) (Log Scale) Europe Mirrors Japan s Experience Japan and Euro Area, Forecast Versus Reality 150 100 Euro Actual 14% Below Expectation 13% Below Expectation Japan Actual 50 1983 1988 1993 1998 2003 2008 2013 2000 2005 2010 20 15 Sources: OECD 1992 Long Term Prospects For The World Economy, IMF 2007, 2007 & 2014 WEO Database 5
Falling Potential A Global Phenomenon Change in 2013 Potential Output Estimate Since 2007-20 +6 Sources: Laurence Ball Long-Term Damage From The Great Recession in OECD Economies, IMF WEO 2008 & 2014 6
Recent U.S. Business Cycles Financially Unsustainable Sources: Federal Reserve, Bureau of Economic Analysis 7
European Credit Boom Sources: World Bank, Bloomberg 8
2.5 Real Yield Curve Before and After Crisis US TIPS Yield Curve 2.0 1.5 1.0 2008 - Jan 2015 - Jan 0.5 0.0 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20-0.5-1.0 Sources: Federal Reserve Refet S. Gürkaynak, Brian Sack, and Jonathan H. Wright, Bloomberg 9
Expected Rates Have Plunged Rate Five Year/Five Years Forward Now Year Ago Nominal 2.3 4.2 Inflation 1.8 2.5 Real 0.6 1.7 Sources: Federal Reserve Refet S. Gürkaynak, Brian Sack, and Jonathan H. Wright, Bloomberg (End of January 2015 vs. 2014) 10
Secular Stagnation Dates To The 1930s 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 11
Liquidity Trap Framework 12
Possible Savings/Investment Curves 13
Percent of GDP Percent of GDP Percent of GDP Private Investment Shortfall 30 Eurozone 28 26 24 22 20 18 2000 2002 2004 2006 2008 2010 2012 28 USA 40 Japan 36 24 32 28 20 24 20 16 2000 2002 2004 2006 2008 2010 2012 Sources: IMF 2014 WEO Database 16 2000 2002 2004 2006 2008 2010 2012 14
Real Interest Rate World Rates Have Fallen Steadily 5 World Real Interest Rate 4 3 2 1 0 1985 1990 1995 2000 2005 2010-1 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
Contribution By Region (At Annual Rate) Demographics Challenging 0.8% 0.7% 0.7% Advanced Economy Change in Working Age Population 0.6% Europe 0.4% 0.1% US & Canada 0.0% Asia (Japan, Korea, Hong Kong, Singapore, & Australia) -0.1% -0.2% -0.3% -0.2% -0.1% -0.4% 1995-2000 2000-2005 2005-2010 2010-2015 2015-2020 2020-2025 2025-2030 2030-2035 2035-2040 Sources: United Nations Population Division, IMF 18
100=1947 Capital Investment Has Gotten Cheaper 115 Relative Price of Fixed Investment vs GDP 110 105 100 95 90 85 80 75 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 Sources: Bureau of Economic Analysis 19
Corporations Have Less Investment Needs Sources: Fortune Magazine, Company Financial Reports 20
Percent of Global GDP Rising Reserve Accumulation 16% World Foreign Exchange Reserves Emerging Economies 12% 8% Advanced Economies 4% 0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Sources: International Monetary Fund s COFER Database, IMF 21
Increased Demand For Safe Assets Sources: Treasury Borrowing Advisory Committee 2013 Q2 Discussion Charts, p.60 22
Percent of Total Income Rising Inequality 25 Income Share of Top 1% 20 15 10 5 0 1913 1923 1933 1943 1953 1963 1973 1983 1993 2003 Sources: World Top Incomes Database 23
Percent of GDP And Rising Corporate Profit Share 12% After Tax Profits and Retained Earnings 10% Profits After Tax 8% 6% 4% 2% Retained Earnings 0% 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 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 Sources IMF October 2014 Global Financial Stability Report 26
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 Sources: Bloomberg 28
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
Percent of GDP But Has Been Hit By Austerity 2.5% Net Public Investment 2.0% 1.5% USA 1.0% Eurozone 0.5% 0.0% 1971 1976 1981 1986 1991 1996 2001 2006 2011-0.5% Sources: US Bureau of Economic Analysis, Eurozone AMECO database 36
Other Possible Responses Public equity investments Work sharing Population and immigration policies 37