Bryan Caplan  

Answering Arnold's Challenge

You Don't Know the Best Way to... I've Changed My Mind...
Tyler publicizes a challenge from founding EconLog blogger Arnold Kling:
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.
My reconciliation:

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."

Original Summers explanation:
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.

Comments and Sharing

COMMENTS (3 to date)
Hazel Meade writes:

Aren't interest rates also a function of the degree of trust in the market, which is, to an extent dependent on the stability of the legal institutions that enforce contracts?

If you have no ability to take someone to court to recoup a loss, you cannot trust the people you are lending to, and therefore, you will generally charge a higher interest rate. This is why interest rates in black markets are generally very high.

Woiuldn't the same thing have been true historically, when governments were less stable and the legal mechanisms for enforcing contractes less well established?

Lupis42 writes:


Overly glib - interest rate is not as interchangeable with return to capital as you imply.

As I understand the Secular Stagnation hypothesis, it is that the real interest rate is negative - that doesn't mean that nominal rates are negative, because they will reflect risk.

Mike Rulle writes:

Each term in this puzzle needs to be defined---and they are not. Needless to say, that will not prevent me from opining.

I do not see why return on capital cannot increase even if secular growth does not. Return on capital should not be dependent on growth. Imagine the next generation of 3D printers which can recreate themselves and make everything for very little---uber productivity. But simultaneously, humans desire for children, goods, and services decline while a desire for contemplation rises. A few knuckle dragging capitalists remain to keep the self generating machines going, which continue to produce less in absolute terms but on a decreasing percent of capital required---which declines at a marginally faster rate than goods and services demanded.

This can continue almost indefinitely until the last person is standing. I am kind of joking. But I think this is true.

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