Adjudicating the Krugman-Bernanke debate on secular stagnation

Here is Krugman’s long and complex post, do read it carefully.  Here are a few points:

1. Bernanke said that non-secular stagnation in other countries might cause capital outflows and thus exchange rate depreciations in the potentially ss (secular stagnation) countries, thereby boosting their exports and demand.

2. Krugman argues in return that those real interest rate differentials will be offset by expected exchange rate appreciation, so the capital outflows won’t be so profitable.  Why switch funds from a stagnating Europe to a non-stagnating India, if expected euro appreciation will wipe out potential profits in India from the point of view of an investor in Europe?

3. I think that is the wrong comparison of interest rates and the wrong metric of expected currency appreciation.

4. Rather than looking at real interest rate differentials, take the market’s implied prediction for the euro to be the forward-futures exchange rates.  These futures rates match the differences in nominal rates on each currency across the relevant time horizons.  Those equilibrium relationships hold true with or without secular stagnation, whether in one country or in “n” countries, and from those relationships you cannot derive the claim that expected currency movements offset cross-border differences in real rates of return.

4b. (It is the nominal rate here because, from the point of view of a European investor, your final real return in terms of your own unit of account depends on a combination of the nominal rate abroad, combined with expected future currency conversion rates.  Got that?)

5. In that setting, rates of return in non-ss countries still will drive capital flows toward those countries (and an exchange rate depreciation, and thus higher exports, for the origin country, in this case the eurozone.)

6. The best way to speak of the non-ss countries, for international economics, is that their corporate sectors offer nominal expected rates of return which are relatively high, compared to their nominal government bond rates.  Once you see this as the correct terminology, it is obvious that capital still will flow outwards to the non-ss countries, even with expected exchange rate movements.  The excess profits are there, capital flows out, the euro weakens or appreciates less strongly, and eurozone exports are stimulated, as Bernanke had analyzed.

7. Theory aside, some of the empirics suggest exchange rates often are close to a random walk (pdf), as opposed to being predicted by nominal interest rate differentials.  This still supports the Bernanke hypothesis.

8. Yes, I am familiar with the Frankel (1979) strand of the literature on how real interest differentials can forecast currency changes, but it is actually a theoretical puzzle that domestically measured real interest rates (sometimes) have had this explanatory power.  And most importantly in this literature high real rates of return tend to predict currency appreciation, not depreciation, so funds should flow all the more to the higher return venues.   It is not a rigorous relationship in any case.  And on top of that Mishkin (1984), among others, has shown such an equalization on the real interest rate, across borders, is rejected by the data.

9. So I agree with Bernanke.  We should not think of real interest rate differentials as being washed out by expected currency movements.  And then the flow of investment abroad can break the secular stagnation chain of reasoning.

10. Bernanke is not arguing that “currency movements and export boosts will set everything right.”  I take him to be suggesting “if the problem were so fully one of the demand-side, currency movement and export boosts could set everything right.”  But since it seems they can’t set everything right, we should infer it is not a problem of the demand side only.  That is a subtle but important difference in argumentation.

11. Personally, I favor supply-side over demand-side analysis for the long run.


Can we invest our way out of secular stagnation (which I use in the broad sense of any imbalances)? The problem with Krugman's emphasis, aggregate demand, which is based on the experience of the last major financial and economic crisis, 1929 and the years that followed, is that it seems misplaced, if for no other reason (although it is a big reason) than the responses by the Fed and government were so radically different. What's been done following the 2008 crisis is an aggressive monetary stimulus, an on-going monetary stimulus, that has been successful in both stopping the collapse in the value of financial assets and restoring that value to a pre-crisis level. In other words, it has been successful in restoring the conditions that existed pre-crisis. Did inattention to aggregate demand cause the crisis? Larry Summers said (in his Okun lecture as the crisis was unfolding) the cause was inattention to "inflation" that was lurking in the background. He's since modified his diagnosis and his prescription. Krugman? With all that monetary stimulus, and with the world's economy awash in cash, why has capital investment continued to lag? Confidence? Or do owners of capital see higher returns in speculation in financial assets? Are the returns in speculation actually higher taking risk into account? What is the risk if the Fed will always intervene and support the value of financial assets. The advantage of theory is that it's based on theory; the disadvantage is that it's based on theory. Bernanke and Krugman (with Cowan as observer) are engaging in a debate in two very different worlds with very different sets of circumstances. It's a Mars and Venus thing.

"Why switch funds from a stagnating Europe to a non-stagnating India, if expected euro appreciation will wipe out potential profits in India from the point of view of an investor in Europe?"

Exactly, non-stagnating countries are often emerging markets which are inherently riskier. Their expected return should be larger, even if you buy that interest rate parity determines exchange rates.

These very long-winded discourses filled with far-flung assumptions and airy predictions are certainly always profitable. Economists have an excellent record in prophesy, and, after all, all things human are calculable.

You're not alone, Ben. I don't have a clue on this one either.

Let's start a club for people who can't follow economic reasoning but feel superior to economists. We'll hold lotteries to see who gets to use the "prophet", "fraud", and "weather man" phrases in a given week.

Let's put some numbers on these return scenarios. The Canadian dollar lost 20% vs the US dollar over a period of a few months, probably connected to the collapse in commodity prices in the 50% range. This coincided with a few trends, a slowing in China, increased supply of commodities, and the end of the QE regime. Similar effects were felt earlier in place like Brazil.

I didn't see an increase in exports from the US. Is say it was the other way around. Pharmaceuticals are hurting, a large industry that was once a major manufacturer is now being bought out, manufacturing abandoned and the distribution used for products from offshore. Very innovative and high tech ones, by the way.

The Bernanke asset price fixing scheme was very effective in allowing government deficit spending without short term downside, has recouped the 2008 losses for investors. Commodity development and investment in technological advances has set the take for a long future of industrial development without worry about shortages. Now the challenge will be not to use that font of industrial capacity to level the civilized world. I doubt that the raging civil war consuming 1/5 of the world population won't affect everyone else. Bernanke can be proud that the QE induced commodity price increases started it all.

The two items I don't see in any of enough in these models are:

1) Is capital becoming more productive? (but also at a higher diminishing returns?)v Due to globalization and more experienced IT/computer users and programs, companies are getting more with IT spend but this less expenditures. In the office experience, new software upgrades are adapted much quicker and better than 15 years ago. As a country we spend less on computers than 10 or 20 years ago but getting a lot more from them.

2) How is the Developed World Baby Bust effecting Macroeconomic Models? Having more people is the one variable that directly effects both the AD & AS curves. Given that Japan hit both the Baby Bust (1971ish) and secular stagnation (early 90s) first, there appears to be a correlation. (So Germany and China are fast fowarding to the modern Japan economy.) Note less children would effect the AD curve first (families buy less stuff) and then effect the AS curve 20 years later. (less young labor....Notice the low skill wages increasing suddenly in the US in 2015.)

Who doesn't favor supply side over demand side for the long run?

Rick--I am beginning to wonder if I do. Blah blah blah the supply side---but who will invest if there is not demand?
People invest in plant and equipment when they think they're going to hit Fat City.
Not because interest rates moved 0.25%.
Can a monetary news ever result in robust economic growth? In the real world, when did ever tight-money result in robust economic growth?

My amateur take is that supply side is what matters in the long run but you do have to get to the long run which means going through the demand side. Or something like that. Anyway, demand side problems in the short or shorter run would likely impact the supply side. There must be a synthesis somewhere?

Was there demand for a powerful handheld computer and communication device? If you asked Nokia they would say no, but apple says yes, as well as google and Samsung. But for it to become as common and as cheap as it is, which has made them indispensable required substantial investment in many technologies, from memory, batteries, processor, power management, the various sensors, GPS, the cellular network coverage as well as the various business and distribution systems. If it didn't dork as well as it does, or was more expensive it wouldn't create demand. Ask Motorola.

Same with the great opportunities for employment in Alberta, where investment in technologies took a marginal oil reserve into a major driver of the Canadian economy. Oddly when the socialist NDP government of Saskatchewan lousy power the same thing happened in that province.

Demand is fine, and is necessary for service industries or providers of housing or transportation, but some supply side investment is necessary to create growth.

Stagnation continues in editing. s/lousy/lost. Dork/work.

Interest rates are irrelevant as the past decade has illustrated (the exception is Greenspan's front-running of market rates in 2004 - 2007). What matters is resources (to squander). No resources and money becomes a worthless claim against it regardless of what it costs to borrow. There is nothing to support future demand for it (forward money).

Marginal cost of capital (non-renewable resources) is beyond what marginal customer can afford (by way of his borrowing capacity). This last is not a bank problem per se. BTW: dollar rise viz other 'Brand N' currencies is preference due to its purchasing power relative to fuel supply: dollar is hard in 2015 the same way it was in 1932 (convertible to gold then, to gasoline, now).

Secular stagnation = ongoing oil price crash. Only question is what came first chicken (stagnation) or egg (unaffordable fuel).

After having reached a certain level of fame, are economists no longer required to express their ideas in models? I have yet to see anyone give a model (with, you know, markets clearing and rational expectations and stuff) of secular stagnation. Are these guys just so good that they all know precisely what model they would write down, and how they would incorporate all these different channel effects they go on about, and the solutions of all those models are obvious to them?

" with, you know, markets clearing and rational expectations and stuff "

Haha. Good one.

I think TC sets himself too easy, too useless a task in point 11, as some guy once said (if that's what he *really* meant).

Amazing issues here. I'm very glad to see your article.
Thank you so much and I am taking a look forward to contact you.
Will you please drop me a mail?

Great post. I'm going through a few of these issues as well..

The debate on secular stagnation is getting very muddled as the economists who originally revived it recast their position in the face of contrary US data and shift to trying to apply the thesis to Europe and Japan. Europe at least has persistent high unemployment, but I personally don't understand what secular stagnation means in reference to Japan, where employment is persistently full.

Good day very nice website!! Guy .. Excellent .. Amazing ..
I'll bookmark your site and take the feeds additionally?
I am satisfied to find so many helpful info here in the put up, we want develop extra techniques on this regard, thank you for sharing.
. . . . .

Comments for this post are closed