As policymakers and investors continue to fret over the risks posed by today’s ultra-low global interest rates, academic economists continue to debate the underlying causes. By now, everyone accepts some version of US Federal Reserve Chairman Ben Bernanke’s statement in 2005 that a “global savings glut” is at the root of the problem. But economists disagree on why we have the glut, how long it will last, and, most fundamentally, on whether it is a good thing.
Bernanke’s original speech emphasized several factors – some that decreased the demand for global savings, and some that increased supply. Either way, interest rates would have to fall in order for world bond markets to clear. He pointed to how the Asian financial crisis in the late 1990’s caused the region’s voracious investment demand to collapse, while simultaneously inducing Asian governments to stockpile liquid assets as a hedge against another crisis. Bernanke also pointed to increased retirement saving by aging populations in Germany and Japan, as well as to saving by oil-exporting countries, with their rapidly growing populations and concerns about oil revenues in the long term.
Monetary policy, incidentally, did not feature prominently in Bernanke’s diagnosis. Like most economists, he believes that if policymakers try to keep interest rates at artificially low levels for too long, eventually demand will soar and inflation will jump. So, if inflation is low and stable, central banks cannot be blamed for low long-term rates.
In fact, I strongly suspect that if one polled investors, monetary policy would be at the top of the list, not absent from it, as an explanation of low global long-term interest rates. The fact that so many investors hold this view ought to make one think twice before absolving monetary policy of all responsibility. Nevertheless, I share Bernanke’s instinct that, while central banks do set very short-term interest rates, they have virtually no influence over long-term real (inflation-adjusted) rates, other than a modest effect through portfolio management policies (for example, “quantitative easing”).
A lot has changed since 2005. We had the financial crisis, and some of the factors cited by Bernanke have substantially reversed. For example, Asian investment is booming again, led by China. And yet global interest rates are even lower now than they were then. Why?
There are several competing theories, most of them quite elegant, but none of them entirely satisfactory. One view holds that long-term growth risks have been on the rise, raising the premium on assets that are perceived to be relatively safe, and raising precautionary saving in general. (Of course, no one should think that any government bonds are completely safe, particularly from inflation and financial repression.) Certainly, the 2008 financial crisis should have been a wake-up call to proponents of the “Great Moderation” view that long-term volatility has fallen. Many studies suggest that it is becoming more difficult than ever to anchor expectations about long-term growth trends. Witness, for example, the active debate about whether technological progress is accelerating or decelerating. Shifting geopolitical power also breeds uncertainty.
Another class of academic theories follows Bernanke (and, even earlier, Michael Dooley, David Folkerts-Landau, and Peter Garber) in attributing low long-term interest rates to the growing importance of emerging economies, but with the major emphasis on private savings rather than public savings. Because emerging economies have relatively weak asset markets, their citizens seek safe haven in advanced-country government bonds. A related theory is that emerging economies’ citizens find it difficult to diversify the huge risk inherent in their fast-growing but volatile environments, and feel particularly vulnerable as a result of weak social safety nets. So they save massively.
These explanations have some merit, but one should recognize that central banks and sovereign wealth funds, not private citizens, are the players most directly responsible for the big savings surpluses. It is a strain to think that governments have the same motivations as private citizens.
Besides, on closer inspection, the emerging-market explanation, though convenient, is not quite as compelling as it might seem. Emerging economies are growing much faster than the advanced countries, which neoclassical growth models suggest should push global interest rates up, not down.
Similarly, the integration of emerging-market countries into the global economy has brought with it a flood of labor. According to standard trade theory, a global labor glut ought to imply an increased rate of return on capital, which again pushes interest rates up, not down.
Surely, any explanation must include the global constriction of credit, especially for small and medium-size businesses. Tighter regulation of lending standards has shut out an important source of global investment demand, putting downward pressure on interest rates.
My best guess is that when global uncertainty fades and global growth picks up, global interest rates will start to rise, too. But predicting the timing of this transition is difficult. The puzzle of the global savings glut may live on for several years to come.
The opinions expressed here are those of the author, not necessarily those of the World Economic Forum. Published in collaboration with Project Syndicate.
Author: Kenneth Rogoff, a former chief economist of the IMF, is Professor of Economics and Public Policy at Harvard University.
Image: A man works a lift as financial headlines play across a ticker in New York REUTERS/Jeff Zelevansky
- Robert J. Samuelson
- Opinion Writer
The Reinhart/Rogoff brawl
An insistent question of our time is, how much government debt is too much. Is there some debt level that becomes crushing as opposed to merely costly? The controversy over research by economists Carmen Reinhart and Kenneth Rogoff shows how explosive the issue is. They suggested that debt exceeding 90 percent of a country’s economy (gross domestic product, or GDP) corresponds to a sharp drop in economic growth. But their work is being challenged by three other economists, who say that Reinhart and Rogoff made basic errors that invalidate their results.
This dispute, which would normally be confined to obscure scholarly journals, has assumed greater visibility because it involves the debate over deficit spending. One group of economists and policymakers argues that annual deficits must be cut because they’re creating — or have already created — dangerous debt levels. Another group contends that large deficits are needed to propel stronger recoveries and reduce huge unemployment.
It’s “austerity” versus “stimulus.” If debt exceeding 90 percent of GDP is hazardous, then the case for austerity seems stronger. (Already many countries exceed or are approaching the 90 percent mark.) If not, deficit spending remains a possible temporary spur. Which is it? Although the newly discovered errors in Reinhart and Rogoff’s 2010 paper (“Growth in a Time of Debt”) are embarrassing, they do not alter one of its main conclusions: High debt and low economic growth often go together.
Glance at the table below. It compares the annual economic growth rates of 20 advanced countries from 1945 to 2009 at various debt levels. The debt-to-GDP levels are given in the left-hand column. The next two columns show the annual economic growth rates estimated by Reinhart and Rogoff and then by the challenging economists from the University of Massachusetts. (They are Thomas Herndon, Michael Ash and Robert Pollin; Reinhart and Rogoff are both at Harvard.)
| Debt/GDP | Annual economic growth, 1945-2009 | |
| | Reinhart/Rogoff | UMass economists |
| 0-30% | 4.1% | 4.2% |
| 30-60 | 2.8 | 3.1 |
| 60-90 | 2.8 | 3.2 |
| 90+ | -0.1 | 2.2 |
After recalculating the Reinhart/Rogoff data, the UMass economists confirm that high debt implies lower economic growth. At the highest debt levels, growth is half what it is at the lowest debt levels. Whether debt causes low growth or merely reflects economic weakness is undetermined. But the UMass economists debunk the notion that growth collapses when debt hits 90 percent of GDP. One problem with the Reinhart/Rogoff study: A coding error excluded five countries — Australia, Austria, Belgium, Canada and Denmark — from the calculations.
Still, these modest mistakes have inspired outlandish allegations. “Did an Excel coding error destroy the economies of the Western world?” asked economist Paul Krugman in his New York Times column. Well, no. The Reinhart/Rogoff paper was published in January 2010, more than a year after Lehman Brothers’ failure and the onset of the financial crisis. At that point, all the ingredients of Europe’s debt crisis (housing bubbles in Spain and Ireland, huge budget deficits in Greece, weak banks throughout the continent) were also in place.
“How much unemployment was caused by Reinhart and Rogoff’s arithmetic mistake? That’s the question millions will be asking,” suggests Dean Baker of the Center for Economic and Policy Research, a left-leaning think tank. Actually, millions won’t ask, and the answer is: probably none. History may or may not judge Europe’s austerity a mistake, but German Chancellor Angela Merkel — its chief advocate — was not taking her cues from Reinhart and Rogoff. Her policies reflect strongly held German beliefs and values.
Something similar can be said of British Prime Minister David Cameron. He took office in May 2010 when the Reinhart/Rogoff paper still enjoyed standard academic obscurity. Cameron’s decision to make deep cuts in Britain’s budget deficits, then running about 10 percent of GDP, was controversial. At most, Reinhart/Rogoff provided some intellectual cover for policies that would have occurred anyway.
The charge that Reinhart and Rogoff cooked their numbers to support a preconceived policy position is contradicted by their 2012 paper (“Public Debt Overhangs: Advanced-Economy Episodes Since 1800”). It showed that results varied by country and that the slowdown at the 90 percent debt/GDP level was generally more gradual. As for American “austerity,” there hasn’t been much. Though declining, budget deficits remain large and the Federal Reserve’s monetary policy remains loose.
What’s sobering about this brawl is that it settles nothing. With some exceptions, most advanced countries, including the United States, seem caught in a similar trap. Their debt/GDP ratios are high and rising, so it’s hard to embrace massive deficit-financed stimulus programs. But austerity programs of spending cuts and tax increases may dampen growth and raise debt/GDP ratios. There is no obvious exit from this dilemma except a burst of spontaneous growth, which is conspicuous by its absence.
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