The Debt Supercycle Versus Secular Stagnation

Kenneth Rogoff has been advancing theories that the electrical flow surround of disappointing growth rates is the outcome of a "debt supercycle", non "secular stagnation". He of late summarised his arguments inside the article "Debt supercycle, non secular stagnation". Although would deal that some version of a "debt supercycle" theory is correct, I am unconvinced virtually Rogoff's description of the mechanisms. Meanwhile, I doubtfulness that he volition succeed inward winning the declaration - he is pushing against the unmoveable object that is the circular logic of the natural charge per unit of measurement of interest.

H5N1 Traditional View Of The Debt Supercycle

I volition start start amongst an overview of how I would characterise a debt supercycle. There appear to live differences from how Kenneth Rogoff views this concept, but his description appears also narrow. It is based on the description of the concept used past times i of my onetime employers, BCA Research, every bit good every bit the related theories of Hyman Minsky. The concept has been around for decades.

The menses before the rising of the welfare solid ground was characterised past times precipitous depressions. The cost degree was famously stable (on average) - at that spot were precipitous deflations which restored the cost degree later the inflation that occurred during the expansion. The autumn inward prices would typically forcefulness the liquidation of borrowers. As a result, socially acceptable debt levels were quite low. The liquidation of the Great Depression was the final instance of this sort of process.

From the perspective of the debt supercycle theory, what is of import was that it did non be inside this before era. Debt levels were forced dorsum to depression levels during the depressions. The economic scheme appeared to live self-correcting, in addition to this belief is embedded inward mainstream economics, which has taken mortal debt semi-seriously inside Dynamic Stochastic General Equilibrium models entirely later the Financial Crisis.

The advent of the welfare solid ground changed the environment. The automatic stabiliser of the key authorities deficit prevents depressions (only the raw incompetence of euro zone policy makers has allowed depression weather to convey origin inward a developed economy).

H5N1 side lawsuit of depression prevention is that debt is no longer liquidated. Although at that spot are periodic recessions, mortal sector debt levels are even therefore high coming out of them. During the expansion, to a greater extent than debt is layered on top.

This is where the borrower hierarchy given past times Minsky comes inward (hedge borrowers, speculative borrowers, in addition to Ponzi borrowers). Since borrowers are non culled during the downturn, aggressive lenders do non pay the cost of lowering credit standards. Since they are expanding lending faster than to a greater extent than conservative lenders, lending standards deteriorate over time.

So far, I get got described what is happening inward the mortal sector. But the reaction of the authorities to this surround is also important. The emission of debt past times whatever entity inside the economic scheme for consumption or investment inward existent goods in addition to services adds to nominal incomes. (The buy of existing assets amongst debt has at best an indirect influence on growth.*) We do non demand financial policy to larn a "multiplier" on deficit spending; mortal sector deficits volition do the task every bit well. An absence of mortal sector debt expansion is unsafe for growth, in addition to therefore massive efforts are made to preclude a liquidation of borrowers. This takes the shape of lender-of-last resort operations, regulatory forbearance inside the banking system, in addition to discretionary counter-cyclical financial policy.

The Financial Crisis of 2007-2009 (which morphed into the eurozone crisis of 2010-) was entirely the latest in addition to largest of these periodic financial crises that get got striking since the mid-1960s. The declaration was that the unwillingness of the authorities to allow the liquidation of borrowers was i element that led to the inflationary bias of policies inward the 1970s.

The Rogoff Version Of The Supercycle

I volition start banking concern complaint that I get got non studied all of Kenneth Rogoff's writings on this topic, therefore I volition continue my comments hither somewhat brief. I get got read a few of his articles (including the i linked to earlier), in addition to my comments hither are based on those writings. It may live that at that spot are some subtleties that I get got missed.

Rogoff's version does non appear to get got every bit well-developed a "narrative structure" every bit does the description of Minsky. His appears to live based mainly upon the empirical move he took amongst Carmen Reinhart inward the volume This Time Is Different. They looked at centuries of information to essay in addition to run into if at that spot are statistical commonalities around financial crises. Their declaration is that later a financial crisis, irksome growth is typical, in addition to somehow pre-ordained past times the laws of statistical repetition.

I am unimpressed amongst this empirical work. Lumping together random financial crises from a broad multifariousness of institutional systems is theoretically incoherent. It ignores the key structural intermission that the welfare solid ground represents.

The U.S. of A. has had periodic financial crises since the mid-1960s. What sets the electrical flow i apart has been an unwillingness of policymakers to loosen policy to increase the growth rate. The mortal sector is unable to generate plenty momentum to force nominal gross domestic product growth rates to a higher house a 4% annual rate. Rogoff pins the blame on regulatory changes that favour "safer" borrowers. Given the scale of lending to shale fracking, I honour it hard to get got that lenders are truly that conservative. The reality is that at that spot is no appetite to repeat the extremes of subprime residential lending of the final cycle, in addition to at that spot is no other sector that is large plenty to offset the bias towards irksome growth inside the economy.

Will Lose The Argument Versus Secular Stagnation

Mainstream economists volition most probable justice the secular stagnation sentiment every bit winning the debate. The secular stagnation story is that the natural involvement charge per unit of measurement has fallen for some ground or another, in addition to this is the explanation for irksome growth.

Nobody spends also much fourth dimension thinking virtually how the natural involvement charge per unit of measurement is estimated. Unfortunately, the techniques used volition simply tell us that if growth is "below potential", in addition to therefore the natural charge per unit of measurement of involvement is lower than whatever the electrical flow involvement charge per unit of measurement is. The fact that this is circular is its greatest strength: it is impossible to defeat a non-falsifiable viewpoint inward a debate.

Rogoff's declaration is that i time the "deleveraging cycle" is over, the economic scheme volition re-accelerate. In his view, this would stand upwards for a victory for the debt supercycle story over the secular stagnation explanation. Unless some sector of the economic scheme of a abrupt develops a wishing to emit large quantities of debt, he is most probable incorrect inward that assessment. He is relying upon his mismatched historical aggregated data, without looking at the underlying economical mechanisms.

In summary, he has seat himself inward a largely indefensible position, fifty-fifty though his sentiment is belike closer to beingness correct.

Policy Recommendations

He contrasts his policy recommendations amongst those of the "secular stagnationists". Although I powerfulness closer to his sentiment of the mechanisms behind irksome growth, his recommendations are dubious.

He attempts to justify austerity policies.

However, those who would debate that fifty-fifty a really mediocre projection is worth doing when involvement rates are depression get got a much tougher instance to make. It is highly superficial in addition to unsafe to debate that debt is basically free. To the extent that depression involvement rates outcome from fearfulness of tail risks a la Barro-Weitzman, i has to assume that the authorities is non itself exposed to the kinds of risks the marketplace is worried about, particularly if overall economy-wide debt in addition to pension obligations are close or at historic highs already. Obstfeld (2013) has argued cogently that governments inward countries amongst large financial sectors demand to get got an ample cushion, every bit otherwise authorities borrowing powerfulness move really expensive inward exactly the states of nature where the mortal sector has problems. 

This logic is extremely weak. The start employment is that government's get got express command over their debt levels. As nosotros get got seen inward the post-Financial Crisis period, austerity policies irksome growth in addition to may inward fact ultimately enhance debt levels.

Mainstream financial analysis largely ignores the wishing of the mortal sector to enhance its stock of financial assets. If at that spot are of import actors that insist upon accumulating such assets, the entirely means of deflecting those desires is for the mortal sector to increase its debt issuance.

The 2nd employment amongst this logic is that an out-of-control financial arrangement tin easily accumulate a stock of bad debts that dwarfs the existing stock of authorities debt. This was the instance inward Ireland, Espana in addition to Iceland. None of those countries were considered to get got "high" debt levels going into the crisis, therefore having "fiscal space" proved to live ultimately worthless.

He also attempts to reinforce Carmen Reinhart's dubious theories virtually financial repression.

Alternatively, if i views depression involvement rates every bit giving a imitation sentiment of the broader credit surface (as Geanokoplos argues), i has to worry whether higher authorities debt volition perpetuate the political economic scheme of policies that are helping the authorities finance debt, but making it to a greater extent than hard for pocket-size businesses in addition to the middle course of pedagogy to obtain credit.

This is an endeavour to revive loanable funds doctrine, but using financial repression every bit the machinery for crowding out. There is absolutely no foundation for this theory, in addition to it is contradicted past times the post-war experience. The strong growth of the 1950s in addition to 1960s was largely financed past times highly regulated banking sectors. The existent estate construction blast that was necessitated past times the babe blast was mainly financed past times Savings in addition to Loans that followed the straightforward 3-5-3 rule.** By contrast, the "sophisticated" modern financial arrangement was unable to finance a smaller construction moving ridge inward the 2000s without blowing itself up. (Warren Mosler enjoys making this observation.) Given adequate aggregate demand, the mortal sector volition honour financing for profitable projects regardless of the degree of regulation.

Footnotes:

* Technically, an economic scheme tin grow inward nominal terms fifty-fifty amongst falling debt levels. But this is an odd situation, every bit it requires entities to get got cash levels that are falling relative to their incomes. Therefore, it volition non live sustained inward practice.

** Pay 3% on deposits, lend at 5%, on the golf game course of pedagogy past times iii pm.

See Also:

• Book Review: Secular Stagnation: Facts, Causes in addition to Cures.
• The article "Wage-led Growth" past times Engelbert Stockhammer. This summarises some of his interrogation on wage-led growth, including the 2013 volume he wrote amongst Marc Lavoie. This interrogation programme argues that the slowdown inward growth ("secular stagnation") is driven past times the drib inward the wage portion of full income.

(c) Brian Romanchuk 2015