Larry Summers interest rate conundrum - dbresearch.com.pdfVIP

Larry Summers’ interest rate conundrum Thomas Mayer 16 January 2014 arry Summers has invoked old theories of secular stagnation to explain the Lpersistence of low interest rates in the recent past. The German economist Carl Christian von Weizsäcker has pointed to a retirement savings glut as the cause for low rates. Both theses, however – that of secular stagnation and of a retirement savings glut - are theoretically doubtful and not supported by empirical evidence A more plausible explanation for sluggish growth and low interest rates in recent years is the fall-out from the recent credit boom-bust cycle. Larry Summers’ most famous predecessor as prophet of secular stagnation was Alvin Hansen. Against the background of the Great Depression of the 1930s, he published his thesis in a 1938 book, just one year before the US economy took off on a high, long-term growth path. In a slightly rambling speech to the attendees of the IMF’s Economic Forum on 8 November 2013, Larry Summers wondered whether theories of ‘secular stagnation’ were possibly relevant for understanding the performance of the US economy. In his view, the US economy has behaved as if “the short-term real interest rate that was consistent with full employment had fallen to -2% or -3% sometime in the middle of the last decade”. If this were the ‘new normal’, Summers felt that “we may well need, in the years ahead, to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back below potential”. One probably has to be Larry Summers to be able to trigger a debate with such vague comments, which were even qualified by the self-critical observation that “this may