Extending Greenspan’s Remarks on the Equilibrium Real Rate
A fat cat is not in good shape. And feeding it more, will not give it energy to be more athletic.
Greenspan said… “in assessing real rates [of interest], the central issue is their relationship to an equilibrium interest rate, specifically the real rate level that, if maintained, would keep the economy at its production potential over time. Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation–below that level with eventual resource bottlenecks and rising inflation, which ultimately engenders economic contraction.”
This statement does not go far enough. I will extend it… “below that level leads to resource bottlenecks, sectors of inflation, rising debt, and if the rate stays below for a long time in conjunction with other policies to raise debt, the rate becomes useless against a rising heavy weight of increased debt and socially non-productive investment, especially when labor share is dropping. An even lower rate at that point tries to push debt even higher with disappointing results that look like secular stagnation.”
I see the global economy as flooded with loose monetary policy for too long. Like I wrote elsewhere, the engine of the global economy is flooded by loose monetary policies in the face of large levels of debt, lower effective tax rates on capital and corporations, and falling labor share. (link to previous post)
In the end, one could conclude that our present low rates are still too high because as Greenspan said, “Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation.” However, persistently loose global policies in general toward the engine of economic growth combined with falling labor share will produce the same effect over much time.
Couldn´t agree more! And most important are non-productive investments incl. credit-consumtion/future consumtion) by households. Raising resident-real estate prices in a speedy manor is certainly a misallocation of capital.
As Bob Prechter used to say “When every one can get Jaguars, Jaguars will soon be out of demand” Yes and thats very deflationary.
The Federal Reserve Bank has depended on stimulating spending by lowering interest rates. That was their response to any recession. If the economy overheated they would raise interest rates.
But in the 21st century the Fed never raised interest rates back to some reasonable rate after a recovery from a recession. (However reasonable might be defined.) If they had done that they would have pushed the economy back into a recession. Doing that would have been a loud and clear warning that the economy as then configured was not sustainable! Which should have caused them to look for changes which had been made to the economy leading up to the 21st century. But the mere fact that they could not raise rates back to some normal rate should also have been a loud and clear warning.
I believe that they must have searched for an answer. But there are none so blind as those who will not see!
The Fed and mainstream economists made themselves blind. The alternative was too unpleasant. Giving up long held assumptions is painful. The changes they found should not have mattered. Demand in an economy actually mattered??? The benefits of free trade were more than countered by the damage it caused??? (There is no utopia???)
The Fed can not create music, they can only turn the volume up or down and even that capability has limits. The music they heard came from several sources and their only tool was not selective, it affected them all.
There was no real rate level which “would keep the economy at its production potential over time.” Not in the structurally damaged economy of the 21st century. Their attempts to stimulate the main street economy provided the funding to drive massive bubbles and massive debt.
Continuing the last paragraph in my previous comment.
In case it is not immediately obvious, the growth of the massive debt meant that the stimulation of the main street economy would only be temporary. After consumers maxed out their credit, most of the stimulation could only fund speculators who would produce massive bubbles.
There is an interesting article today written by Larry Summers:
He contrasts his position with Paul Krugman’s and concludes with this:
“But it seems to elide the main issue. Where is the deus ex machina? Where is the can opener? The essence of the secular stagnation and hysteresis ideas that I have been pushing is that there is no assurance that capitalist economies, when plunged into downturn, will, over any interval, revert to what had been normal. Understanding this phenomenon and responding to it seems the central challenge for macroeconomics in this era.
Any analysis that assumes restoration of previous equilibrium is, from this perspective, missing the main issue. I was glad to see Paul recognize this point recently. I suspect it will lead to more emphasis on fiscal rather than monetary actions in depressed economies.”
He is getting to the problem, but he can not describe the “can opener”.
You believe that labor share is too low and I believe that problem was brought on by free trade treaties. So from my perspective, tariffs are the “can opener”.
Either we find a “can opener” or the fact that we have downsized our economy will be apparent to everyone after we stop using zero interest rates and QE.
Zero interest rates and QE are not the “can opener”.
I am reading your comments.
Here is a thought… The United States is the best. So why don’t we just keep on being the best by not racing to the bottom with other countries? Raise effective tax rates on corps and high incomes, re-distribute wealth through govt transfers, raise wages to lighten that transfer load on the govt,, raise wages a bit higher than productivity growth…
It seems the US is underselling itself…