Gavekal Capital: Secular Stagnation & Personal Savings

Friday, August 29, 2014

Secular Stagnation & Personal Savings

In his Presidential Address to the American Economic Association in December 1938 Alvin Hanson presented his "secular stagnation" hypothesis.  He argued that US faced a crisis of deficient demand and underinvestment due to declining population growth after the closing of the frontier to new immigrants. One of the main driving forces of the secular stagnation hypothesis was the decline in the birth rate and oversupply of savings.  This hypothesis presented the possibility that no achievable interest rate would balance savings and investment at full employment.

Th secular stagnation argument has received renewed attention lately.  In the words of Larry Summers, "We may have found ourselves in a situation in which the natural rate rate of interest--the short-term real interest rate consistent with full employment--is permanently negative."

Gauti Eggertsson and Neil Mehrotra of Brown University have recently developed a new model that explains the  secular stagnation hypothesis very clearly. "In our model of secular stagnation, however, no such return to normal occurs.  Instead, a period of deleveraging puts even more downward pressure on the real interest rate so that it becomes permanently negative.  The key here is that households shift from borrowing to savings over their life-cycle.  If a borrower takes on less debt today (due to the deleveraging shock), then tomorrow he has greater savings capacity since he has less debt to repay.  This implies deleveraging--rather than facilitating the transition to a new steady state with a positive interest rate--will instead reduce the real rate even further by increasing the supply in the future.

Today's personal income and spending report was interesting through the lens of the secular stagnation argument.  Since the beginning of the year, US consumers have increased their savings rate, saving almost 40% of each marginal dollar of personal income this year.  The savings rate has risen from 4% to 5.7% this year.  A higher savings rate is generally associated with lower levels of consumer credit (deleveraging) as shown in the chart below.


It's also associated with diminished levels of demand.  Here we compare the savings rate with residential investment as a percent of GDP.  A rising savings rate is not good news for the housing contribution to GDP.


The Fed's extraordinary monetary policy of quantitative easing has tried to counter-act the effects of the secular stagnation the US has found itself in for the last five years.  The New York Federal Reserve did a study a few years ago that equated $800 billion in asset purchases as equivalent to 100bps reduction in the fed funds rate.  In the chart below we integrate that concept alongside the traditional fed funds rate.  We are somewhere around -4.25% using this proxy.  If there is a durable, new turn toward greater savings, perhaps this rate has to further to fall.  Today's report gave the supporters of the secular stagnation hypothesis (perhaps the Fed too) something to think about.