How effective is monetary policy?
Łukasz and Summers quantitatively assess the impact of the slowdown in productivity growth, the demographic shifts, and the rise in income inequality on real interest rates. They show that taken together, all these factors under-explain the decline in advanced economies’ neutral real rate.
On the other hand, their model suggests that government policies pushed up the equilibrium interest rate by around 4pp over the past 50 years.
What does our analysis say about stabilization policy? Most obviously it says that traditional levels of interest rates combined with balanced budgets or even stable debt-GDP ratios are a prescription for recession. Policymakers must, if they wish to avoid output being demand constrained, do some combination of accepting high and rising deficits and government debt levels, living with real interest rates very close to zero or negative, and finding structural policies that promote investment or reduce saving.
On falling neutral real rates, fiscal policy, and the risk of secular stagnation
Authors: Łukasz Rachel, Lawrence H. Summers
From: LSE and Bank of England, Harvard University
