Secular Stagnation Solutions

Larry Summers has been writing about Secular Stagnation for Two Years. This is the post which triggered the trialogue

It is an excellent and important post, but I will just take the non technical definition of Secular Stagnation

The core idea behind secular stagnation was that the neutral real rate had for a variety of reasons fallen and might well be below zero a substantial part of the time going forward. The inference was that economies might be doomed to oscillate between sluggish growth and growth like that of the 2003-2007 period that rested on an unstable financial foundation.

And click the link to Summers’s discussion of Lukasz Rachel and Thomas Smith’s recent research.

in which he wrote

they attempt to quantify most of the factors that I and others have enumerated in accounting for declining real rates. They note that since the global saving and investment rate has not changed much even as real rates have fallen sharply there must have been major changes in both the supply of saving and demand for investment. They present thoughtful calculations assigning roles to rising inequality and growing reserve accumulation on the saving side and lower priced capital goods and slower labor force growth on the investment side. They also note the importance of rising risk premia associated in part with an increase financial frictions. Rachel and Smith’s work is not the last word but it is the first important word on decomposing the causal factors behind declining real rates.

Here I note that the role of rising inequality in causing secular stagnation provides a new argument for increased progressivity of taxation. I have advocated increased progressivity for 35 years and did so when I thought the resulting reduction of savings rates was a drawback not an advantage. But the case is even stronger if it is a feature not a bug.

Second, secular stagnation can make risk premia which did not cause huge problems in the past extremely costly. If a risky rate required for full employment is much higher than the risk premium minus the rate of inflation, then full employment is not consistent with the lower bound on safe nominal interest rates. This means that a low neutral real rate is another reason why governments should bear (or hide) risk. This means that the risk of secular stagnation increases the strength of a case for a sovereign wealth fund through which the US Federal Government purchases risky assets. I have been arguing for one for 10 years, but the case is even stronger if secular stagnation is a risk. It is not necessary that risk premia have increased. The formerly

Summers made this argument here.

The central banks of Europe and Japan need to be clear that their biggest risk is a further slowdown. They must indicate a willingness to be creative in the use of the tools at their disposal. With bond yields well below 1 per cent it is very doubtful that traditional QE will have much stimulative effect. They must be prepared to consider support for assets that carry risk premiums that can be meaningfully reduced.

For political reasons, the possible public purchasers of risky assets currently commonly considered* are central banks and not the Social Security Administration but the substance is the same.

*”real rate required” was an alliteration I tried to avoid, but I added the two in this sentence as jokes.

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