Planet Money - The life and possible death of low interest rates

Episode Date: April 15, 2023

Right now, the economy is running hot. Inflation is high, and central banks are pushing up interest rates to fight it. But before the pandemic, economies around the world were stuck in a different rut: low inflation, low interest rates, low growth. In 2013, Larry Summers unearthed an old term from the Great Depression to explain why the economy was in this rut: secular stagnation. The theory resonated with Olivier Blanchard, another leading scholar, because he had made similar observations himself. Larry and Olivier would go on to build a case for why secular stagnation was a defining theory of the economy and why government policies needed to respond to it. They helped reshape many people's understanding of the economy, and suggested that this period of slow growth and low interest rates was here to stay for a long time.But today, Larry and Olivier are no longer the duo they used to be. As inflation has spiked worldwide, interest rates have followed suit. Earlier this year, Larry announced that he was no longer on the secular stagnation train. Olivier, meanwhile, believes we're just going through a minor blip and will return to a period of low interest rates within the near future. He doesn't see the deep forces that led to a long-run decline in interest rates as just vanishing. Who's right? The future of the global economy could depend on the answer.Help support Planet Money by subscribing to Planet Money+ in Apple Podcasts or at plus.npr.org/planetmoney.Learn more about sponsor message choices: podcastchoices.com/adchoicesNPR Privacy Policy

This is Planet Money from NPR. For the last year or two, we have been in a certain universe, a universe of high inflation and higher interest rates than we're used to. The economy has been overheated, as they say, which is not great. But not too long ago, just before the pandemic, we had the opposite problem. We were in a universe of abnormally low inflation and abnormally low interest rates. The economy was underheated, we'll say, which is also not great. Some inflation is good. Really, there's a sweet spot.

Yeah. Low inflation and low interest rates are signs that something is wrong with the economy. And for years, it seemed like nothing we did could get us out of the low interest rate, low inflation rut, not just in the U.S., but around the world, in Germany, in Italy, the U.K., Japan. And economists were saying, it looks like we're going to stay in this universe for a long time. Obviously, we have now left that universe. Oh, yeah, big time. But one leading economist is saying, yeah, but we'll likely return to that old universe of low inflation and low interest rates once things settle down. Another leading economist, though, is like, I'm not so sure. Larry Summers, you're saying, no, we're going to be in a whole different universe now.

I'm saying at least there's a substantial chance of that, yes. So you're leaning like the world we've known is probably not going to come back anytime soon. Sarah, the world we knew I think is unlikely to come back, yes. Hello and welcome to Planet Money. I'm Greg Rosalski. And I'm Sarah Gonzalez. So will interest rates come back down or are we destined to stay in the universe we are in now of high interest rates? Like if you're trying to buy a home, should you wait or should you buy now? The decision you make might come down to which economic theory you believe in. Today on the show, it's a bromance of the mind, if you will.

And a sort of falling out over the future of the economy. All right, the debate about what kind of economy we might have in the future also happens to be a tale of friendship, maybe a little rivalry, between two leading economists. Larry Summers, professor of economics, Harvard University. Hey, Larry Summers. Larry frickin' Summers, former U.S. Treasury Secretary, former president of Harvard, super respected, but sometimes controversial for some people. Known to be a little prickly, seemingly does not love it when you interrupt him, but was generally very friendly when we talked. Thank you for joining us today, sir.

Glad to be with you, Greg. Glad to be with you too, Sarah. And the other economist, Olivier Blanchard. He's the former chief economist of the International Monetary Fund, the IMF. And I'm going to say also a little prickly, but also really funny and charismatic. Yeah. And apparently the IMF agrees because they wrote probably the most flattering description of him possible. I was looking at what they wrote about you and they said prolific and popular a demi-god half economist

half artist yeah i i think that my god is i mean is ambiguous yeah no i would like it to go all the way i mean i i just let's go olivier met larry at a discotheca they were both dancing to staying alive and oh no that's absolutely not how they met. Actually, they met at Harvard in 1977. He was actually my teaching assistant. Oh, wow. He was a different kind of teaching assistant. I think he knew as much as I did or more. But he has always been very nice with me.

And in the years since then, Olivier and Larry have become like real buddies, like best friends. What do you guys do together at a carousel? You guys, you golf or what do you do? He golfs, he golfs. He's actually a surprisingly good athlete, despite appearances. You look like a good athlete, sir. Exactly.

I look the part. The difference is that he plays the part. He's actually a very good tennis player, and he has this way of not moving on the court, but always being where the ball is, which makes me very unhappy. Okay, can we get serious? And let's start discussing.

Let's start. Okay, so let's start. Let's get in our time machines for a second. All right, to understand what kind of economic universe we might be in in the future, we really have to go back to the past, to November of 2013. It's on the heels of the financial crisis. There's this big economic conference. The theme is crisis.

The actual theme. And all the big wigs are there. Ben Bernanke, Paul Krugman, Christina Romer, and obviously, Larry Summers and Olivier Blanchard. Now, we were technically in the recovery period after the crisis, but the recovery was pretty pathetic. Economic growth was slow and millions of Americans were still out of work. And economists were struggling to explain why this was happening. Enter Larry Summers. I am very glad for the opportunity to be here.

He gives this big speech to all these fancy economists and uses this phrase, these two words, that changes absolutely everything, at least for some economists. I wonder if a set of older ideas that went under the phrase secular stagnation are not profoundly important. Secular stagnation. Now, secular here does not mean secular in the non-religious way. It just means long term. It's the much less common definition of secular in the dictionary. long-term. It's the much less common definition of secular in the dictionary. And stagnation, well, I mean, stagnant, right? Not moving, not growing. So secular stagnation really just means long-term economic sluggishness. The term was first coined in the 1930s during the

Great Depression, when the economy was stuck in this rut of low growth. We weren't building things and unemployment was high. And no matter what anyone did, it seemed like the economy just couldn't get out of this rut. And in 2013, Larry Summers was saying, I hate to break it to everyone, but I think we have entered that rut of slow growth again. Larry said we were again in a period of secular stagnation. Olivier Blanchard was there watching his buddy Larry say this. And Olivier and a lot of economists actually were like, I knew something was up with the economy, but I couldn't quite put my finger on it. I started realizing that interest rates were very low and had steadily declined for a long time. But I didn't put a name on it. The person who put a name on it was Larry. And,

you know, names are important. You end up being remembered for some of the names you introduce. You know, it crystallizes something that is happening. After this, Olivier kind of joined Larry. They became sort of an intellectual dynamic duo on secular stagnation, doing research together, writing papers, hosting conferences about how major this new thinking could be for the economic world. Because secular stagnation is more than just an annoying way of saying slow growth. This is how Larry Summers describes it. Secular stagnation, more savings than investment. Higher unemployment. More deflationary tendency than inflationary. And very low interest rates and very slow growth.

Yeah, there are a lot. But if you ask Larry Summers what the simplest definition is, he will say it is when there's an imbalance between two fundamental parts of the economy. Between savings and investment, and how that leads to abnormally low interest rates. Now, interest rates are just the price of borrowing money. Borrowers usually want to borrow money so they can invest in something, like starting a new business or expanding an existing one. And lenders, who are usually banks, take our savings, think the money we have in our savings accounts, and lend it out. This is what is called the market for borrowing.

And after the financial crisis, something really weird was going on in this market. The price of borrowing, the interest rate, was super low. And still, no one was borrowing. And it was a difficult period for the overall economy. Because you know what happens when no one's really borrowing? No one's really investing. People weren't starting new businesses or building new factories, which means they're also hiring fewer people to make things and sell things, right? This is not good for jobs. Yeah. In periods of secular stagnation, we are investing less.

This is a huge part of secular stagnation, low investment. And we really started to feel this right after the financial crisis. And like, sure, you could say investment was just low during this time because we already had a lot of what we needed, right? Like we already have plumbing systems and electrical grids and buildings and cubicles and machines and all that kind of stuff. So you don't really like need as much investment when you already have a lot of the things that you need. But also when you do need to invest, Larry says it's just a lot cheaper now because of technology. My $600 cell phone has more computing power than a $50 million supercomputer did 25 years ago. So even if somebody wants to buy the same amount of computing power as before, they're going to absorb a lot less savings in the process of doing it. Yeah, savings. So while secular stagnation was a world that lacked investment,

it was also a world where people had a lot of savings, especially older people like baby boomers. When people are expecting to age, they save more. Yeah, when people are expecting to like retire soonish, many of them save money so they could, I don't know, like one day play golf or go on a cruise or whatever. And Larry says globally, people were getting richer and they were getting older. They were expecting to retire. And so they were saving more.

It was a world where there was basically a huge volume of people who wanted to save. And when you have a glut of people saving, and remember, not a lot of people investing, Larry says that is what caused interest rates to fall. Because everyone was like, don't you want to borrow my money and invest in new things? And all these other people were like, no, I'm good. Thanks. That's right. Not a large volume of people who wanted to put that savings to work. And therefore, the savings flowed into existing assets. Meaning they turned to like buying more houses. That's right.

They bought more houses. They bought more existing stocks. bought more houses, they bought more existing stocks. But Larry says when all the savings are going into homes and stocks, it was causing bubbles and financial instability. And importantly, it was not getting invested in new businesses and new factories that actually grow the economy and create jobs. Yeah, jobs. Larry Summers and Olivier Blanchard were super concerned about what secular stagnation meant for jobs. Typically, the Federal Reserve plays a big part in trying to boost employment. Their main tool is cutting interest rates. They do this to encourage borrowing, you know, to get people to buy stuff and invest in things, spend money.

So it creates jobs. Cutting interest rates is like a magic tool for trying to create jobs. But during the financial crisis, the Fed already cut interest rates to zero. And we got there and then stayed there. That's Olivier again. And then you get a bomb, which is, well, this is not enough. I mean, suppose that you need an even lower interest rate. Yeah, the Fed kind of hit a wall when interest rates got to zero.

Yeah, the Fed kind of hit a wall when interest rates got to zero because somehow basically free money wasn't enough to convince people to start borrowing and investing to get the economy growing again. advocating for a new playbook, one that they thought could actually fight the problems caused by secular stagnation. And the main thing they suggested was a pretty big departure from mainstream economics, that governments should start aggressively borrowing and spending. So you can see that conceptually, you're moving from one world to another world. And the world was not ready for this. Countries, some politicians were like, no, no, no, no, we do not borrow, please. We don't want more government intervention, more debt. Larry and Olivier would spend a decade being like,

okay, well, that's why you're in this rut of long-term sluggishness. You gotta spend money to get out of it, to get out of secular stagnation. And for a while, it seemed like this secular stagnation bromance between Larry and Olivier would just go on forever, bouncing ideas off of each other, laughing, frolicking, rethinking bedrock economic ideas. But then, in January of this year, Larry Summers announced in a big public way that he was taking a break from secular stagnation.

It just wasn't for him anymore. Wow. Do you remember where you were when you first learned he was no longer on the secular stagnation train? And how did that feel? Like total betrayal. Oh, this is getting juicy. This is the stuff that people want to hear. After the break, a major blow to this legendary friendship.

Will it survive? Oh, and also, what's going to happen to interest rates and inflation? Are we going to stay in this universe we're in now where everything is expensive? Or is there hope that prices will come down soon? Larry and Olivier agree that we have left the period of secular stagnation. The question is, is it dead or is it just taking a little nap? secular stagnation. The question is, is it dead or is it just taking a little nap? Well, earlier this year at the big annual American Economic Association conference, Larry Summers, the chief secular stagnationist, weighed in with an interesting pre-recorded video.

Where were you when you made this announcement out of curiosity? In all honesty, I don't remember where i was you were on a beach do you remember that part of it there was like a ocean larry suspects he was in jamaica because that's where he says his family typically vacations and he kind of got roasted online about this video it looked a little bit out of touch to some people, but it was apparently not his call to film there. If I were more sensitive to appearances, I probably would have insisted myself in denying you this bit of humor by filming it in a more neutral kind of hotel room. From the beach, palm trees ever so slightly swaying in the background,

Larry Summers sort of beams in. I'm sorry not to be at the meetings in person this year. And he makes his big announcement. My guess is that we will not return to an era of secular stagnation. That's right, Larry says. Secular stagnation is probably dead. So you're leaning no. Interest rates will probably not go down for a while?

I'm leaning, but it's a pretty tentative kind of lean. Yes, that's right. I think it's possible that we're going to be in a world of higher interest rates and possibly more inflationary pressure. Yeah. Higher inflation, higher interest rates, higher mortgage rates for a while, probably. Do you recognize what's going on here? What about Olivier? Larry is flirting with a different economic theory just out there in front of everyone.

Take us into that dynamic. Like, is it awkward? Has he called you? Has he been like, what the heck, Larry? Olivier and I are good friends. And I think we both have a pretty good understanding of each other's arguments. All right. Here's why Larry Summers thinks secular stagnation is probably not coming back. He sees what's happened in the past few years as very similar to what's happened in the past, in the 1930s, when we were in the original secular stagnation rut. It took something really big to get out of that rut.

World War II. The government spent a ton of money during and after the war, and all that investment and spending pulled us out. Well, something very much like fighting World War II happened after COVID. The government injected over two years more than $5 trillion in fiscal stimulus. Yeah, both the Trump administration and the Biden administration spent a ton. And Larry and Olivier say that spending did get us out of the rut. But they say it's probably also what caused inflation and the higher interest rates.

They think we overdid it on spending. Now, some economists say, come on, that's not what caused inflation. Even if it did, that government spending happened a long time ago at this point. It's mostly working its way through the economy already and won't even really matter soon. But Larry says, oh, no, no, no. The spending period is not over. Larry says we're in for even more investment and spending going forward, which could keep interest rates and maybe inflation high, because Larry thinks we're going to be investing in a lot of new green technology. We're going to be replacing many power plants, paying for retrofitting. We're going to be making large-scale investments in batteries. So the green transition will operate in the direction of increasing investment.

Also, since Russia invaded Ukraine, Larry is expecting more investment in the military. Like, we used to think we could fight wars just with, like, drones or whatever. But maybe we still need tanks after all. Lastly, Larry says our demographics are changing. just with like drones or whatever. But maybe we still need tanks after all. Lastly, Larry says our demographics are changing. Remember before when Larry said that baby boomers were preparing to retire and so they were saving a lot and that this glut of savings was a big part

of why interest rates were abnormally low? Well, many of those people have retired now. And apparently once you do retire, you spend your savings. Once people have aged and they're retiring, then they draw down their savings and spend. And so I think we're making a transition from more saving because of aging to less saving because aging has happened. So it's kind of like a double-edged sword, the aging one? The aging one is, yeah, yes. And all these things, Larry says, higher investment in green technology and in the military

and lower savings because retirees are spending could mean higher interest rates going forward. But his buddy Olivier is like, I'm not so sure, Larry. I think we will indeed be going back to a period of secular stagnation. You wrote recently, disagreeing about secular stagnation with the first macroeconomist to identify it rightly as a contemporary phenomenon is something one should do very carefully. Yet I must. Yeah, those are fighting words. phenomenon is something one should do very carefully, yet I must. Yeah, those are fighting words. I mean, discussions with Larry are just incredible fun intellectually, but very tough.

He will always start by saying, I have three things to say, one, two, three, four, five, six, seven. But we have long discussions. And on this topic, I think it's really a question of probabilities. But we have long discussions. And on this topic, I think it's really a question of probabilities. First, Olivier has less faith that we will actually invest a lot in green technology. He definitely thinks we should, you know, to fight climate change.

He's just like, not sure it's actually going to happen. I'm a bit less optimistic about green investment. I suspect we'll do some, but maybe not a lot. Also, on the aging thing, Olivier's like, come on, people are going to continue living longer. So if anything, they'll be saving for more years of retirement because they're living longer. So on the age saving thing, Olivier thinks there will still be a too much savings issue. Bottom line, Olivier doesn't think high interest rates are here to stay. He actually just published a new book called Fiscal Policy Under Low Interest Rates. So yeah, he's clearly in the low interest rate camp.

People tend to extrapolate and say, well, we have high rates. We're going to have high rates in the future. Secular stagnation is dead, right? No, it's taking a rest. Yeah. Olivier thinks secular stagnation is going to wake up somewhat soon. Maybe a little cranky because, you know, secular stagnation is kind of a fussy baby. To be clear, both Olivier and Larry agree that going back to an economy of secular stagnation would not be great.

And also that staying in the economy we have now would also not be great. I think what we want to be seeking is a happy medium. We don't want to be in a situation of secular stagnation. We also don't want to be in a situation of an unsustainable and overheated economy. Yeah, they're on the same page there. It's just that Olivier thinks we cannot ignore the huge forces that kept us in secular stagnation for so long. I think that you cannot dismiss what had happened for 40 years before COVID and that there were deep forces at work and there is no reason whatsoever to think that automatically they are gone. The other thing that I feel very strongly is that this inflation episode is an inflation episode, not a permanent thing which will change things forever.

We've gone through many episodes before. They come, they go. All right. So some of you may have picked a side already in this epic secular stagnation divorce, and you might be curious what it means for you. If you believe Larry, here's what that could mean for your 401k, your retirement, basically the stock market. That would tend to lead you to expect that this would be a less happy period ahead for the stock market. Sell, sell, sell. Just kidding. Of course, there can be no certainty.

So that's stocks in Larry's universe. What about homes? Should you just suck it up and buy now when mortgage rates are pretty high? Or should you wait because they might come down soon? Yeah. Should I buy a house now, Larry? Should I buy a house? If you love the house, you probably should. If the house is just an investment, you probably shouldn't. But if you are team interest rates will go back down, team Olivier, it's a different story. Should I buy a home? I see.

That's the reason we have this interview. You want to know what the mortgage rate will be next year. Yes. Okay. I think that mortgage rates will come down substantially. Wow. That's actually very useful information, sir. How much do I get paid for this? That's a very good question, sir.

I'll be charging my hourly rate on that one. Whatever happens with secular stagnation and interest rates could have some real big consequences. If Larry's right, that's super worrisome. It means that it's just going to be much more expensive for governments to borrow. It could make U.S. debt grow out of control and make it much harder to invest in things we want to invest in. If Olivier is right, though, I mean, there will still be problems, yes, but it might be a slightly less scary and cheaper world. I mean, if I'm right, I will be seen not as a demigod, but three quarters or more. I mean, it's just the guy who actually had it, right?

You're going to be a full god at that point. Humility is really of the essence in that case. Yeah, yeah, yeah. No, you exhibited brilliantly. Yeah, yeah, yeah. No, you exhibited brilliantly. We are happy to report that despite this epic change of heart, the bromance is still going strong. They are not playing tennis together anymore. But Olivier says it's not any indication of lack of friendship. It's more that they live 3,000 miles apart. Really, Olivier says, it's always been more of an intellectual friendship anyway.

Today's show was produced by Willa Rubin with help from Emma Peasley. It was engineered by Maggie Luthar. It was fact-checked by Sierra Juarez and edited by Jess Jang. Special thanks to Josephine J. McAuliffe. I'm Sarah Gonzalez. And I'm Greg Rosofsky.

This is NPR. Thanks for listening. And a special thanks to our funder, the Alfred P. Sloan Foundation, for helping to support this podcast.