Does the Egertsson and Mehrotra model of secular stagnation work?

Their new paper is here, ungated here (pdf), here is the key passage:

We have shown that in the model with capital, the presence of productive assets carrying a positive marginal product does not eliminate the possibility of a secular stagnation. The key assumption is that capital has a strictly positive rate of depreciation. In the absence of depreciation, capital can serve as a perfect storage technology which places a zero bound on the real interest rate. It is straightforward to introduce other type of assets, such as land used for production, and maintain a secular stagnation equilibrium. For these extensions, however, it is important to ensure that the asset cannot operate as a perfect storage technology as this may put a zero bound on the real interest rate.

Let me recapitulate the basic problem.  Secular stagnation models are supposed to exhibit persistent negative real rates of return, but how is this compatible with economic growth and positive investment?  Just hold onto stuff if need be and of course the goverment can help you do this with safe assets, if need be.  The earlier models had no capital, which ruled out this possibility.  The new model assumes storage costs for capital are fairly high, or alternatively the depreciation rate for capital is high.  Since you can’t sit on your wealth, you might as well invest it at negative real rates of return.

But at the margin, storage costs for goods (and some capital) are not that high.  My cupboard is full of beans and cumin seed, but I eat the stuff only slowly.  In the meantime it is hardly a burden, nor is it risky since I know it will be tasty once I make the right brew.  Art has negative storage costs (for the marginal buyer it is fun to look at), although its risk admittedly makes this a more complicated example.  Advances in logistics, and the success of Amazon, show that storage costs are getting lower all the time.

Secular stagnation might be a good model for Liberia and Venezuela and Mad Max, but not for the United States today or other growing economies with forward momentum.  But a credible stagnation model for America needs to recognize that rates of return will be lower than usual but not negative in real terms.  And there won’t be a long-run shortfall of demand because eventually market prices will adjust so that demand meets the supply we have.  That is a supply-side stagnation model of the sort promoted by myself, Robert Gordon, Peter Thiel, Michael Mandel, and others.  In the secular stagnation model as it is now being discussed by Keynesian macroeconomists, you end up twisting yourself in knots to force that real rate of return into permanently negative territory.  Of course if you allow the real rate of return to be positive albeit low, the economy is not stuck in a perpetual liquidity trap as people move out of cash into investment assets.  The demand-side stagnation mechanisms fade away into irrelevance once prices have some time to adjust.

Izabella Kaminska comments here.  Josh Hendrickson has a very good blog post on the model here.  I’ve already cited Stephen Williamson here, he notes the model is really about a credit friction and would be remedied with a greater supply of safe assets for savings, an easy enough problem to solve, for instance try the Bush tax cuts.  Here is Ryan Decker on the model, and here is Ryan arguing that investment is aggregate demand also and many of us seem to have forgotten that, a very good post.

This is an important and interesting paper, but only because it shows the model doesn’t really hold and requires such contortions.  The discussion of policy results is premature and way off the mark.  The authors should have included sentences like “storage costs aren’t very high, and the economy as a whole does not exhibit negative real rates of return, so these policy conclusions are not actual recommendations.”

Comments

safe assets having a negative real rate doesn't prevent risky assets from having a positive real rate, so I am not sure how stylized facts on the economy as a whole are supposed to work here. Who performs maturity transformation on beans and cumin seed? I am sure that advances in logistics have eased the problem of coordinating maturities but I am not sure the problem is close to solved.

We already have all the stuff we want. We mainly just want to get rid of our neighbors. They cramp our style. Save to buy their land? Or save to move? I'm short oil. The supercycle shows all signs of a super down move.

As far as I can tell, TC is the best economist around at articulating his views in an objective, engaging manner. But I think he neglects the energy markets. The key here is whether oil has entered a new secular decline and, if so, what that means.

I remember that oil needs to be around 70-80 USD per barrel to make fracking profitable. If oil goes below that price, suddenly local US production will go down sending price up again. The only problem is that oil production is not as flexible as prices. Reducing production is easy, increasing it takes months or years.

'Remembering' may not be the best approach... every shale well is different, and the technology is improving over time, driving the breakeven oil price for new drilling lower for the marginal well.

Question/observation from a non-specialist:

Seems to me that you can get some strange and surprising results by using these life-cycle, overlapping generations (OLG) types of models. Another example is this new paper on high optimal marginal tax rates by Kindermann and Krueger.
http://www.nber.org/papers/w20601

These OLG models are interesting and yield some insights, but I'm just not sure to what degree the intuition you get from an OLG model transfers over to a dynastic model, or (more importantly) which insights might transfer to a more realistic model that has elements of both. Are there pitfalls of taking OLG models too seriously? (I'm aware of some pitfalls of taking dynastic models too seriously, like here: http://www.nber.org/papers/w2086 )

I note that Piketty is all about dynasties, and I don't see how his ideas would even make any sense at all in an OLG framework. But I doubt than any of the pundits will notice this when it's time to voxsplain the new research to us.

'The discussion of policy results is premature' and the approvingly cited 'he notes the model is really about a credit friction and would be remedied with a greater supply of safe assets for savings, an easy enough problem to solve, for instance try the Bush tax cuts' obviously have nothing to do with each other, just being another one of those thoughtless coincidences one encounters when discussing matter economic at a GMU econ professor's web site.

In your beans and cumin example, once you have all the beans and cumin you could possibly eat stored away, any further beans or cumin have no value to you and cease to be a low storage cost store of value. At that point the storage and spoilage costs, no matter how low, give it a negative real rate of return. Good stores of value may be finite.

This is an attempted model of global stagnation. It can't be applied on a national level as it disallows cross-border trade and investment.

Hahah Well I'm sure Larry Summers will be discussing Secular Stagnation on his wife's new MOOC about fiction.

Of course, owners of capital won't accept low rates of return on "safe assets"; instead, they will take on greater risk through more speculative investments. In turn, those speculative investments will eventually prove to be just that: speculative. The bubble will burst, a financial crisis will ensue, and the government and Fed will implement rinse and repeat. Secular stagnation is a misnomer: there's nothing stagnant about a financial crisis. The assumption is that the government and Fed will always implement rinse and repeat, but how many times will that be politically feasible. I don't know the answer, but it's not infinite.

Moore's law notwithstanding, there really does not seem to be really compelling reasons to upgrade computers these days. Unlike earlier eras, computing power is not exactly surging forward. Existing computing infrastructure is often perfectly fine with the new (if any of it is new) software apps coming down the line.

Seeing as how robust computing is as a capital good (it can last for decades, many times), I can see it being a store of value and lead to secular stagnation.

The investments Ryan writes about are of course not financial investments but fixed investments, it's not entirely clear to me that he understands this. And the secular stagnation problem with these investments is of course that, in the western world, these have been tending downwards during the 30, 40 years. Initially, the gap was fiulled with government consumption (everywhere), household consumption (USA) or exports (Switzerland, Germany, Netherlands). These strategies may have run their course, surely when we continue to slash wages and incomes. Some data on the investment decline: http://www.paecon.net/PAEReview/issue69/Knibbe69.pdf

This comment is incredibly stupid and demonstrates a near complete misunderstanding of macroeconomics.

In "National Income and the Price Level," Martin Bailey discussed the issues of the liquidity trap and secular stagnation.

He observed that at a zero real interest rate, it would be profitable to level the Rocky Mountains and fill in the Gulf of Mexico. The land created would have a rate of return over zero. Also, replacing all steel with stainless steel would pay off.

The examples get to the problem. If someone wanted to level a mountain and fill in the Gulf, it would take a decade to get EPA approval, if it ever came. At negative real interest rates, there are plenty of profitable investments. Maybe in the medical sector, or energy, or finance, or banking, or education, or transportation....where government approval can block the investment for a decade. Secular stagnation is feasible in a world of heavy regulations and taxes, regardless of technological opportunities or the productivity of capital. Keystone Pipeline, anyone?

In a regulated state, easy Fed policy might boost the stock market and lower bond yields without boosting investment much at all. Sound familiar?

"Advances in logistics, and the success of Amazon, show that storage costs are getting lower all the time"

This doesn't seem right to me. Advances in logistics mean that storage is less and less necessary, since retailers are getting better at predicting demand and quickly delivering products to consumers. That's different from saying goods are getting closer to being a perfect store of value. What percentage of modern goods (and capital) take the form of high-tech machinery and electronics? Is there anything that loses value more quickly? What am I missing?

"In the absence of depreciation, capital can serve as a perfect storage technology which places a zero bound on the real interest rate."

And in the absence of gravity, space travel would require far less energy.

If we could see the ideal (in Plato's Cave) there would be no need for the difficult work of interpreting those pesky shadows.

In a world with negative real interest rates, non-depreciating capital could be attractive. If only there were such a thing, in this non-ideal world.

The main storage technology in use these days is housing. Adair Turner frequently points out that life-cycle saving is done largely via home loans now. He and others note that these loans have become the main part of bank portfolios. In order to understand storage costs, should we not focus on the performance of investments in housing? My understanding of housing bubbles worldwide is that people are trying to use more storage capacity than exists, and society occasionally realizes this, which leads to a correction in home prices.

Some would argue that we rely more on housing than on business loans for storage due to the low risk weights assigned to home loans in bank capital regulations. This argument is developed in detail by Julien Noziet at spontaneousfinance.com

Art, beans, and land would not be risk free non-depreciating assets. Art could lose its value if it goes out of style or new artists appear. Any given piece of land could see its value change.

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