Why are interest rates so low? Does the hypothesis of “secular stagnation” help explain it? What do such low interest rates imply for the likely effectiveness of monetary policy during another recession? What other policies might need to be tried, either as an alternative to monetary policy or a way to make it more effective? These are the most important questions in macroeconomics. They are also hugely contentious.
A recent paper by Lukasz Rachel and Lawrence Summers shines light on these questions. Its thrust is to support and elaborate the hypothesis of “ secular stagnation”, revived by Prof Summers as relevant to our era in 2015. This paper’s principal innovation is to treat the big advanced economies as a single bloc. Here are four conclusions.
First, a dramatic and progressive decline in real interest rates on safe assets has occurred, from over 4 per cent in the 1980s to around zero now. Furthermore, shifts in risk preferences do not explain this decline, since spreads in yields of riskier over safe assets have changed little. (See charts.)