The stagnation headache: Why are people holding back?

• Author: Shiller, Robert J.

Ever since the "Great Recession" of 2007-2009, the world's major central banks have kept short-term interest rates at near-zero levels. In the United States, even after the Federal Reserve's recent increases, short-term rates remain below 1 percent, and long-term interest rates on major government bonds are similarly low. Moreover, major central banks have supported markets at a record level by buying up huge amounts of debt and holding it.

Why is all this economic life support necessary, and why for so long?

It would be an oversimplification to say that the Great Recession caused this. Long-term real (inflation-adjusted) interest rates did not really reach low levels during the 2007-2009 period. If one looks at a plot of the U.S. ten-year Treasury yield over the last thirty-five years, one sees a fairly steady downward trend, with nothing particularly unusual about the Great Recession. The yield rate was 3.5 percent in 2009, at the end of the recession. Now it is just over 2 percent.

Much the same is true of real interest rates. During the Great Recession, the ten-year Treasury Inflation-Protected Security yield reached almost 3 percent at one point, and was almost 2 percent at the recession's end. Since then, the ten-year TIPS yield has mostly declined and stayed low, at 0.5 percent in May 2017.

The fact that people are willing to tie up their money for ten years at such low rates suggests that there has been a long trend toward pessimism, reflected in the recent popularity of the term "secular stagnation" to describe a perpetually weak economy. After former U.S. Treasury Secretary Lawrence Summers used the term in a November 2013 speech at the International Monetary Fund, New York Times columnist Paul Krugman picked it up, and it went viral from there.

Although secular stagnation became a meme five years after the 2008 financial crisis, the term itself is much older. It first appeared in Harvard University economist Alvin Hansen's presidential address to the American Economic Association, in December 1938, and in his book published the same year.

Hansen described the "essence of secular stagnation" as "sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment." When Hansen delivered his speech, he expected the U.S. economy's economic stagnation to persist indefinitely. The depression that had started with the stock-market crash of 1929 was approaching...