Answering Arnold's Challenge
By Bryan Caplan
I still want to see an economist reconcile a belief in secular stagnation with a belief in Piketty’s claim that the return on capital is going to exceed the growth rate of the economy on a secular basis.
Historically, the growth rate has usually been near-zero and interest rates have usually been high. Piketty’s claim is simply that growth and interest rates will revert to their historic norm. Why is that so hard to believe?
Theoretically, interest rates are determined by many factors. Yes, expected economic growth is one such factor: When people expect to be richer in the future, they try to borrow against their future income. But this can easily be outweighed by time preference (see section VIII in my Week 2 micro notes). With stagnant income and slight time preference, interest rates will be positive even though economic growth is non-existent.
Either way, there’s no puzzle.
Update: I interpreted Arnold’s “secular stagnation” as a synonym for very low economic growth. But Arnold emailed me to say that he’s using the phrase differently:
You could quote me as saying, “By secular stagnation, I mean something more specific than just low economic growth. I interpret Larry Summers as saying that real interest rates are permanently low, because of a glut of savings relative to the demand for investment.”
Secular stagnation refers to the idea that the normal, self-restorative properties of the economy might not be sufficient to allow sustained full employment along with financial stability without extraordinary expansionary policies.
In other words, I took “secular stagnation” as a claim about long-run growth, but Arnold was treating it as a claim about long-run demand. My apologies for any confusion, though other economists I know also interpreted “secular stagnation” as I did.