Tuesday, July 15, 2014

Secular Stagnation Versus A Deep and Prolonged Business Cycle

Larry Summers revived the concept of secular stagnation which argues that we are in for an extended period of slower economic growth.  His argument hinges on the relationship between the real interest rate and economic growth.  The real interest rate has been very low for many years and even a negative real interest rate has failed to accelerate the growth rate.  David Beckworth shows that the risk free interest rate has been pretty steady over a number of years and that should be used as the natural rate of interest.  Moreover, the risk free interest rate correlates with the business cycle over an extended time period.  He also argues that positive demographic trends will stimulate growth along with rising productivity.  He concludes that we in the throes of a bad business cycle and that we will return to normal levels of growth just as we did after the Great Depression.  Which crystal ball do you prefer?

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