Evan Soltas
Aug 17, 2014

Secular Stagnation, Meet Data

There is a new e-book out on secular stagnation, with contributions from Larry Summers, Barry Eichengreen, Paul Krugman, Olivier Blanchard, and others. It offers a lot to discuss, but I'm struck by something mostly missing: implied forward real interest rates.

This seems like it should be important data for the hypothesis, but it's only discussed briefly in the chapter by Frank Smets and two other economists. The graph, fittingly enough, is on the very last page of content.

If real interest rates are going to be low for a long period of time, as secular stagnation implies, then the market should say that, and the way it would is through forward rates. So what do we see?

The first graph shows the instantaneous forward real interest rate -- basically, what the market thinks the cost of overnight funding should be in real terms at some future date -- as derived from TIPS yields. There are more precise ways to do this, but it's close enough for a blog post.

Markets anticipate that real interest rates will return slowly to one percent. For reference, prior to the recession, these rates averaged about 1.5 percent, at least on an ex-post basis.

Another way to look at this is to figure out the implied real forwards for longer-term bonds. This builds in market views on what the term premium will be in the future, of course. The market's message is generally the same: Real interest rates will be the same as, or modestly lower than, where they have been in the past. Most of the depressed position of interest rates comes from the short run.

It's early to come to any solid conclusions about what the secular-stagnation discussion has and hasn't accomplished. Yet the thought that lingers for me is: Why do we need "secular stagnation"?

For all the interesting discussion so far, much of it in this book, nothing has yet convinced me that secular stagnation is a necessary and unique component to my understanding -- my mental model -- of the post-recession global economy. What someone who is convinced needs to do is identify the key facts that cannot be explained by deleveraging and the huge shock to nominal income.

The closest anyone has come, in fact, was Summers when he discussed the mid-2000s as a period of mediocre growth despite pedal-to-the-metal monetary policy. Krugman's "observation #2," that there seems to be a long-term trend towards ever-lower real interest rates, is also getting there. The bar, generally speaking, for a new theory to get into a model is that the model's predictions must be otherwise inconsistent with reality.

There just doesn't seem to be such a need for an additional "secular stagnation" component, as I interpret the data above. There is nothing outrageously low about forward real interest rates. If secular stagnation is merely an organizing device, the problem is that it seems to want to say something about the future, whereas the base case of deleveraging and the nominal-income shock speak mainly about the past. That's why the issue must be cast in light of forward interest rates -- and why I remain sympathetic but unconvinced.