World interest rates

Ben Bernanke has joined the blogosphere, offering an invaluable resource for anyone wanting to understand recent economic developments. Last week he had a series of articles examining factors behind the very low real interest rates on long-term bonds.

One interpretation of current low interest rates is that we have moved into an era in which the long-term real return to capital is near zero as a result of factors such as fewer investment opportunities, slower population and productivity growth, and falling labor force participation. Larry Summers argued that the U.S. was only able to achieve satisfactory GDP growth over 2002-2007 as a result of an unsustainable housing bubble and that the strong economic growth of the 1990’s was also partly powered by the tech stock bubble. Larry has elsewhere suggested:

Suppose that the short-term real interest rate that was consistent with full employment had fallen to negative two or negative three percent in the middle of the last decade. Then … 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 economy activity, holding our economies back below their potential.

But last week Bernanke outlined some of the reasons he is not convinced by Summers:

I generally agree with the recent critique of secular stagnation by Jim Hamilton, Ethan Harris, Jan Hatzius, and Kenneth West. In particular, they take issue with Larry’s claim that we have never seen full employment during the past several decades without the presence of a financial bubble. They note that the bubble in tech stocks came very late in the boom of the 1990s, and they provide estimates to show that the positive effects of the housing bubble of the 2000’s on consumer demand were largely offset by other special factors, including the negative effects of the sharp increase in world oil prices and the drain on demand created by a trade deficit equal to 6 percent of US output. They argue that recent slow growth is likely due less to secular stagnation than to temporary “headwinds” that are already in the process of dissipating. During my time as Fed chairman I frequently cited the economic headwinds arising from the aftermath of the financial crisis on credit conditions; the slow recovery of housing; and restrictive fiscal policies at both the federal and the state and local levels (for example, see my August and November 2012 speeches.)

My greatest concern about Larry’s formulation, however, is the lack of attention to the international dimension. He focuses on factors affecting domestic capital investment and household spending. All else equal, however, the availability of profitable capital investments anywhere in the world should help defeat secular stagnation at home. The foreign exchange value of the dollar is one channel through which this could work: If US households and firms invest abroad, the resulting outflows of financial capital would be expected to weaken the dollar, which in turn would promote US exports…. Increased exports would raise production and employment at home, helping the economy reach full employment. In short, in an open economy, secular stagnation requires that the returns to capital investment be permanently low everywhere, not just in the home economy.

In a subsequent post, Bernanke takes a look at those global factors. In 2005 he had noted that global saving and investment flows were reversed from what one might normally expect, with the emerging economies and oil-exporting economies (where one might have thought investment opportunities should be most abundant) having surplus savings with the funds being lent to the developed economies. Bernanke described this situation as a “global saving glut” that contributed to low world interest rates at the time. His blog post last week revisits this issue and notes some important changes since 2005.

Thanks in part to increased domestic oil production, Bernanke notes that the U.S. current account deficit today is significantly smaller than it was in 2005. The periphery European economies have swung from big trade deficits into surplus, while Germany’s surplus has increased. The bottom line is that the developed economies as a group appear to have swung from a position of big deficits into surplus.

At the same time, the surplus of emerging economies has fallen significantly. Latin America has moved from trade surplus to a big trade deficit, China’s saving rate has slowed, and oil producers like Russia have seen a big swing. If oil prices remain at the low levels they reached by the end of 2014, we would surely expect to see further big reductions in the saving from the oil-exporting countries.

By the way, one might wonder how it could be that developed and emerging economies today are supposedly both running a trade surplus. Unless, as Jeff Frankel once facetiously suggested, the earth is currently exporting $587 B in goods and services to other planets, there is a problem with the numbers some of the countries are reporting– the exports that country A claims it sold to country B do not equal the imports that country B claims it bought from A. This is labeled as a “statistical discrepancy” at the bottom of Bernanke’s table. Although these discrepancies are enormous, I think we can correctly infer the broad trends and recognize the direction things are headed at the moment, even if we don’t have full faith in the detailed numbers.

I share Bernanke’s conclusion:

If global imbalances in trade and financial flows do moderate over time, there should be some tendency for global real interest rates to rise, and for US growth to look more sustainable as the outlook for exports improves. To make sure that this happens, the US and the international community should continue to oppose national policies that promote large, persistent current account surpluses and to work toward an international system that delivers better balance in trade and capital flows.

And in his most recent post, Bernanke spells out some of the specific changes he is recommending. He notes that the long-term imbalances within Europe arise from a common currency ill-suited to the different needs of its member states, problems with parallels to those documented by Barry Eichengreen for the 1920s. Bernanke lays out several measures that Germany could take today that could help Germans and everyone else, including increased investment in public infrastructure, raising the wage of German workers, and targeted structural reforms.

The bottom line for investors, whether or not the Germans follow Bernanke’s excellent advice, is this: don’t expect the real interest rate to remain at current negative levels.