Probably, yes
In this commentary, Olivier Blanchard argues that once central banks have won the fight against inflation, we will most likely return to a macroeconomic environment where safe interest rates (r) will again be low, much like the period before COVID. He lists the following three factors:
- Savings: for Blanchard demographics and higher incomes will lead to high savings. In particular, longer life expectancy will prompt people to save more in anticipation of a longer retirement. Higher income levels will enable people to save “for precautionary motives or life cycle saving purposes.”
- Safe rates: higher public debt, due to COVID spending, will increase r but only by 15-30 basis points as a debt-to-GDP ratio in advanced economies has increased only from 75 percent in 2019 to 82 percent in 2022. In addition, demand for safe assets will continue to be strong both because global uncertainty has increased and because banking regulation, that requires financial institutions to hold a higher proportion of liquid assets, is still in place.
- Investments: this is where Blanchard sees more uncertainty. Could technological progress trigger higher investments which will increase r? Will geopolitics lead to higher defense spending, or will reshoring and friendshoring, for security or other reasons, lead to more investments? How about green investments, will these lead to a higher r?
In short, one can never be sure. But I see the inflation episode and the higher rates as an interlude. Looking beyond this episode, I see low interest rates and a negative r − g as the most likely scenario for the future. If I am right, this is the time to think about fiscal and monetary policy once the fight against inflation is won.
Secular stagnation is not over
By: Olivier Blanchard – Peterson Institute for International Economics
Probably, not
Larry Summers compares the current period to the post second-world II period when economists worried that the pre-war secular stagnation of the 1930s could come back. It didn’t then and most probably it won’t now either. He argues that all the structural factors that contributed to the secular stagnation of the 2010s will still be in place but, in contrast to Blanchard’s opinion above, savings, public debt and investments will lead to higher safe interest rates (r).
- Savings: The explosion of consumer lending products provided by FinTech will contribute to the reduction of household savings. In addition, policies that will bring about wealth redistribution will also contribute to the decrease in savings. As for demographics, Summers argues that “an aging society that is aging is different from a society that is anticipating aging in the future” (the type of society Blanchard mentions above) in that the former, i.e. the elderly, will dissave and sell assets. In balance, r will be higher in the next decade than what the Fed anticipates.
- Safe rates: a reasonable rule of thumb, Summers argues, is that a 1% increase in public debt to GDP ratio is associated with a 2.5 basis points increase in r. The current increase in the US public debt to GDP ratio of 30%, should lead to an increase in r of about 80-100 basis points. In addition, higher costs of services the government provides, including an increase in defense spending, will lead to higher deficits.
- Investments: Here Summers is more sanguine than Blanchard as he argues that reshoring and the need to build resilience in supply chains will lead to higher investment. The green transformation as well, which implies the retirement of certain power plants, the retirement of old vehicles as well as expenses on insulation, just to mention a few, will also lead to more investments.
We may be at the beginning of an era of higher interest rates than we have become accustomed to and perhaps even an era of rising interest rates.
Back to Secular Stagnation?
By: Larry Summers – Harvard University
(This is a video recording. The segment with Larry Summers is from 1:36:30 to 1:58:00)
