Are we entering a long period of secular stagnation in which interest rates are low? We cannot foresee all the implications. 

This has not been an easy column to write, and it may not be an easy one to read. Part of the problem is that there is no agreement within the economics profession as how to interpret what is going on. I cannot recall any previous occasion in my lifetime when good economists were so puzzled.  Yet, what appears to be occurring is so fundamental, and may have such a huge impact on our lives, that readers deserve some sort of guidance.

The crucial fact we are trying to grapple with is that world interest rates are low. For the last six years base US interest rates have been near zero while key interest rates in Europe have turned negative. (New Zealand ones sit a little higher. That is because those who lend to us want a premium for exchange rate risk; but even ours have been falling to unusually low levels.)

A number of explanations have been put forward by a galaxy of the world's top economists including, Ben Bernake, Robert Gordon, Paul Krugman, Kenneth Rogoff and Larry Summers. (Yes, they are all Americans and all are broadly Keynesians - serious monetarists hardly appear nowadays, although populist pseudo-economists are inclined to warble on.)

Rather than go through each of their explanations (and tie readers into knots) I am going to offer – ever so tentatively –  my synthesis.

The effect of low interest rates should encourage investment in productive activities. (I'll talk about the impact on finance shortly.) That is not happening. It is possible that there is insufficient demand. But over recent years many measures have been taken to increase investment-inducing demand and they have had little effect. Six years is a long time – longer than from the beginning to the bottom of the Great Depression; you have to go back to the 1880s for a longer period of international stagnation.

The other possibility is that there are insufficient new investment opportunities. Of course there are some - think of the (art deco) cinemas constructed during the Great Depression. But there are not enough to generate a demand for savings to push up interest rates.

In his recently published The Rise and Fall of American Growth Robert Gordon argues that current technological innovations are not as significant as those of 100 years ago; that, for instance, electricity had a far more pervasive impact than computers.

I am a bit embarrassed to challenge such an eminent authority, and neither of us will be around when a comprehensive evaluation can be made. But the problem may not be so much the significance of the new technologies as that it is often difficult to make a profit from them. Your life is being transformed by the digital revolution, but many of the innovations' applications are not profitable. The media cannot work out how to make a profit from their news websites – while traditional media, such as newspapers, make losses. Twitter has not made a profit in ten years.

Suppose that Gordon - or my version of him - is right, then there will be much reduced opportunities to invest reasonably safely and interest rates will fall. The outcome will be the sort of world economy secular stagnation we are seeing. Certainly there remain some high risk investment opportunities with high putative returns but many will bomb out.

The point about the Gordon – or Gordon-plus – analysis is that we may not be experiencing a short-term stagnation. It may be that the world economy is going to remain in a slow growth stage of development for some time. Sure, there will be change, but returns on investments will be low.

This is a rather tentative projection, but it is worth exploring some of its outcomes. A curious one is that as rates of return fall, world wealth inequality may rise even though world income inequality falls. That is because the price of a financial asset rises when returns generally fall.

That induces more financial speculation, which is not underpinned by real economic activity to finance the speculators' consumption; ultimately it implodes. Remember 2008; we may repeat something like it in the not too distant future.

A particular example is housing. As interest rates fall, mortgage debt servicing becomes easier. So you can pay more for your house, the only restraint being the deposit. (That tends to lock out those currently renting - at least until their folks die and they inherit a share of their housing capital gains.) The rising house prices induce speculative investment for capital gains, although that cannot go on forever. I am not sure what happens in the long run.

For if the long-term secular stagnation theory is right, we are in uncertain territory, with outcomes we can only vaguely foresee, if at all.

Let me finish with one further example (thereby ignoring the implications for government spending. Retirees are grumbling that their incomes are being cut by the falling interest rates. So be it. The implication is they are going to have to consume some of their financial savings (so there will be less for their heirs). Systematically running down one's assets is called 'decumulation' (the opposite of accumulation). However exactly how to do it is unclear.

You won't get much guidance from financial advisers and their journalist counterparts, many of whom are likely to be stuck into a high interest mindset long after it becomes clear to everyone else that the world has changed.

Comments (10)

by Robin on March 29, 2016

I'm so confused, especially by "the price of a financial asset rises when returns generally fall" wouldn't a more profitable asset be worth more than one not giving a return? Because it's easier to borrow to buy assets and increased demand makes asset value increase? Or are you saying the profits are used to increase the worth of the asset (company?), rather than paid out as dividends? If interest rates are low wouldn't companies be more inclined to leverage their worth more effectively and therefore be able to pay out more? Either way, why would incomes necessarily increase?
- a financial illiterate. 

by Raymond A Francis on March 29, 2016
Raymond A Francis

I am at retirement age and my financial advisors are picking that we will be in a low interest environment for a long time. My position is I want to beat inflation by 2% or better and have stratagies in place to do that

My advisors think that the high inflation of my working life was an aberration caused by the increased number and demand of the baby boomers. They used inflation graphs going back to 1830s in the UK to show that . 

While big debt works with high inflation even though it is cheaper now debt should only be used for productive items 

We live in interesting times


by Brian Easton on March 30, 2016
Brian Easton


Suppose a bond pays $300 a year in perpetuity when the going interest rate is 3 percent p.a. The market will value the bond at $10,000 (i.e. $300/0.03 -- $10,000 at 3 percent p.a. produces $300 p.a.). Now suppose interest rates fall to to 1 percent p.a. The market will now value the bond at $30,000 ($300/0.01). 

This a stylised example (bonds in perpetuity hardly exist nowadays although they  did in the nineteenth century). But it illustrates the general principles that the value assets with higher existing rates of return rises when there is a fall in the general level of interest rates.


by Alan Johnstone on March 30, 2016
Alan Johnstone

Obviously we can't have perpetual growth; resources and needs are finite.

There is a limit to the infrastructure spending we need. Much of it has already been produced by previous generations and will deliver value for centuries to come.

The low hanging fruit of high return investments have already been built; technology , automation and rising populations will provide some opportunities but these will reduce in value as time goes on. This relates to "future of work" conversations as well. What do people do when automated processes and robots can do your job better than you?

So, we have a glut of fiat money flooding the world, chasing diminishing returns and pushing asset prices ever higher.

It requires a fundamental re-thinking of the capitalist money which relies of constant growth to deliver returns. I have no idea where it goes from here 





by KJT on March 30, 2016

No investment because there are no buyers.

Incomes of the majority are so low that they are either borrowed to the hilt and/or too poor to buy anything except cheap junk.

The inevitable result of the majority of wealth going to those who have so much, they can afford to salt it away.

Dropping everyone's wages and then making them borrow back hugely, to live.

A UBI may yet "save" capitalism from itself.


by Robin on March 31, 2016

Thanks for the explanation!

by John Hayman on March 31, 2016
John Hayman

This seems like an opportunity to begin the large investments in low carbon technologies that are so urgently needed to combat climate change. Can anyone explain why our Government is so reluctant to take any leadership in this area despite our awful record of increasing carbon emissions despite our commitment to reduce them?

by Ian MacKay on April 01, 2016
Ian MacKay

I reckon Alan Johnstone has an answer (above.)

"Obviously we can't have perpetual growth; resources and needs are finite."

In a similar way at what point does the demand for "growth" reach a maximum? We are told that growth is essential in order to sustain an economy. But maybe the current hiatus signals that maximum?

by Fentex on April 01, 2016

I find it hard to believe that coincidental with a major crisis born of fraud in valuing assets there should suddenly be a new normal in interest and bond rates.

And as I read an article today about how the Volvo’s North American CEO lost his temper trying to demonstrate a self driving car on public roads because the roads condition and markings were inadequate and the vehicle refused to move for 'fear' of error through lack of recognizable road I pondered the wide spread reporting about crumbling U.S infrastructure and similar expressions of worry about reduced public spending in many places.

I haven't a thorough theory but it seems to me there's something very wrong in a world where interest rates are going negative in some places, stockpiles of private wealth grow and public spending reduces.

It smells like there's a structural feature of modern economies creating opposing incentives and limiting the flow of capital and I suspect it's probably quite obvious to anyone studying economics who can step back and view the forest.

I dunno, maybe Keynes was right about what to do?

by Murray Grimwood on April 02, 2016
Murray Grimwood

The economics profession went around counting deckchairs. Worked until it didn't.

The deeper we go into the post-peak era, the more sure it is that we will never see global growth again. The fact that it's somewhat unpalatable to most (particularly the First World, the current winners) doesn't change the inevitability of the change.

Bravely tackled, Brian.

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