Wednesday, April 1, 2015

Ben Bernanke Versus Larry Summers On Secular Stagnation

Its great for the economics profession, and for the public, to have Ben Bernanke posting blogs.  Bernanke is not only an outstanding economist but he was also the Chairman of the Fed during a very difficult economic climate.  His blogs reflect the thinking behind the policies adopted by the Fed during that period. Bernanke turns to the future in this blog.  He explains why he disagrees with Larry Summers' secular stagnation hypothesis.

The secular stagnation hypothesis was motivated by the failure of persistently low real interest rates to stimulate aggregate demand.  Summers concluded that we may have entered into a period of low economic growth because business investment and consumer demand were unresponsive to historically low real interest rates.  Periods of rapid growth over the last two decades were assumed to be in response to financial bubbles.  Therefore, sustainable economic growth was not possible without creating risk in the financial system. 

The secular stagnation hypothesis presented a real challenge to the mission of the Fed.  Its mission is to provide employment and price stability as well as financial stability.  Consequently, it is not surprising that Bernanke would seek to escape the constraints on growth and stability that were advanced by Summers.

Bernanke presented evidence which suggested that economic growth was not dependent upon financial bubbles.  US trade deficits were equal to 6% during the financial bubbles.  The bubbles only offset the trade deficits.  Therefore, financial bubbles would not be needed if US trade deficits could be reduced.  Bernanke concluded that the major weakness in the secular stagnation hypothesis is that it fails to consider international trade.  He argued that there must be opportunities for profitable investment somewhere in the global economy.  Capital should flow to places where investments would be profitable even without negative real interest rates.  That would be good for US exports as long as US firms supplied the physical capital to international manufacturing hubs.  The US trade deficit with China, for example, would be reversed if US firms shipped capital equipment to China in return for its finished products.

The US economy has been able to grow despite several headwinds that have restrict economic growth.  The reduced flow of credit, and the slow recovery of the housing market have been headwinds.  Fiscal policy in the US has also been a headwind.  Federal and State spending have been lower than they should have been during a recession.  Perhaps the US economy will resume a sustainable level of growth without financial bubbles as these headwinds dissipate.  Summers would like to agree with Bernanke's positive outlook.  However, he has several concerns about Bernanke's analysis of his secular hypothesis hypothesis.  As long as the amount of savings in the global economy exceeds the amount of business investment aggregate demand will be below the level required for sustainable growth.  Summers believes that government investment should help to equate the relationship between savings and investment.  That is especially true in an era of exceptionally low interest rates.  There must be a large number of productive government investment opportunities at zero real interest rates.

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