Discussion of “A Model of Secular Stagnation:
Theory and Quantitative Evaluation”
by Gauti Eggertsson, Neil Mehrotra and Jacob Robbins
Andrea Ferrero
University of Oxford
Federal Reserve Bank of San Francisco Conference on
“Do Changes in the Economic Landscape
Require a New Policy Framework?”
San Francisco, 21 April 2017
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Introduction
Central tenet of Secular Stagnation hypothesis (Summers, 2014):
Low (possibly negative) equilibrium real interest rate
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
2 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Introduction
Central tenet of Secular Stagnation hypothesis (Summers, 2014):
Low (possibly negative) equilibrium real interest rate
Data: Negative measured real interest rates
Real Short-Term Yields
10
8
percentage points
6
4
2
0
-2
-4
1990
1995
Source: Carvalho, Ferrero, Nechio (2016)
Andrea Ferrero (Oxford)
2000
Median
2005
2010
Mean
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
2 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Introduction
Central tenet of Secular Stagnation hypothesis (Summers, 2014):
Low (possibly negative) equilibrium real interest rate
Data: Negative measured real interest rates
I
Here to stay
Source: Summers (2015)
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
2 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Introduction
Central tenet of Secular Stagnation hypothesis (Summers, 2014):
Low (possibly negative) equilibrium real interest rate
Data: Negative measured real interest rates
I
Here to stay
Need a model to construct equilibrium real interest rate
I
And think about “real interest rate gap”
EMR provide a model of Secular Stagnation
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
2 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Introduction
Central tenet of Secular Stagnation hypothesis (Summers, 2014):
Low (possibly negative) equilibrium real interest rate
Data: Negative measured real interest rates
I
Here to stay
Need a model to construct equilibrium real interest rate
I
And think about “real interest rate gap”
EMR provide a model of Secular Stagnation
A new framework for policy analysis
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
2 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Outline of Discussion
1
Brief summary and key findings
2
Decline of natural rate
3
Policy implications
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
3 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
First part: Three-period OLG model with borrowing constraint
max
Cty ,Ctm+1 ,Cto+2
Et (ln Cty + β ln Ctm+1 + β2 ln Cto+2 )
subject to
Cty
Andrea Ferrero (Oxford)
= Bty = Dt /(1 + rt )
Ctm+1
= Ytm+1 − (1 + rt )Bty + Btm+1
Cto+2
= Yto+2 − (1 + rt +1 )Btm+1
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
4 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
First part: Three-period OLG model with borrowing constraint
max
Cty ,Ctm+1 ,Cto+2
Et (ln Cty + β ln Ctm+1 + β2 ln Cto+2 )
subject to
Cty
= Bty = Dt /(1 + rt )
Ctm+1
= Ytm+1 − (1 + rt )Bty + Btm+1
Cto+2
= Yto+2 − (1 + rt +1 )Btm+1
Population growth: Nt = (1 + gt )Nt −1 ⇒ (1 + gt )Bty = −Btm
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
4 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
First part: Three-period OLG model with borrowing constraint
max
Cty ,Ctm+1 ,Cto+2
Et (ln Cty + β ln Ctm+1 + β2 ln Cto+2 )
subject to
Cty
= Bty = Dt /(1 + rt )
Ctm+1
= Ytm+1 − (1 + rt )Bty + Btm+1
Cto+2
= Yto+2 − (1 + rt +1 )Btm+1
Population growth: Nt = (1 + gt )Nt −1 ⇒ (1 + gt )Bty = −Btm
Productivity growth: Yt = At Ȳ ⇒ Dt = At +1 D̄
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
4 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
First part: Three-period OLG model with borrowing constraint
Get expression for equilibrium real interest rate
rt =
(1 + β)(1 + gt )(1 + xt )D̃t + (1 + xt +1 )Ỹto+1
−1
β(Ỹtm − D̃t −1 )
where xt ≡ At /At −1 − 1
Three factors that can push down real interest rate
1
gt : Demographics (Carvalho, Ferrero and Nechio, 2016)
2
xt : Productivity (Gordon, 2015)
3
D̃t : Deleveraging (Eggertsson and Krugman, 2012)
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
4 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
First part: Three-period OLG model with borrowing constraint
Temporary deleveraging shock ⇒ Permanently low real rate
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
5 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
First part: Three-period OLG model with borrowing constraint
Nice narrative:
I
Real rate already on decline due to trends in demographics and productivity
I
Becomes permanently negative because of crisis (deleveraging)
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
5 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
Second part: Quantitative life-cycle model with
I
Age-specific income profile
I
Mortality risk
I
Bequest motive
I
Capital and CES production
I
Exogenous process for relative price of capital
I
Distortionary labor taxes
Calibrated to US data in 2015: Two options
I
No output gap (Stock and Watson, 2012)
I
Large output gap (Hall, 2016)
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
6 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
Second part: Quantitative life-cycle model
Legitimate to consider 2015 observed real rate as natural real rate but
I
No output gap =⇒
6
Observed real interest rate = Natural rate
I
Need additional assumption economy is in steady state
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
6 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
Second part: Quantitative life-cycle model
Legitimate to consider 2015 observed real rate as natural real rate but
I
No output gap =⇒
6
Observed real interest rate = Natural rate
I
Need additional assumption economy is in steady state
Results robust to alternative measures of output gap ∈ (−15%, 0)?
I
Interesting that no deflation arises with large output gap
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
6 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Summary
Second part: Quantitative life-cycle model
Legitimate to consider 2015 observed real rate as natural real rate but
I
No output gap =⇒
6
Observed real interest rate = Natural rate
I
Need additional assumption economy is in steady state
Results robust to alternative measures of output gap ∈ (−15%, 0)?
I
Interesting that no deflation arises with large output gap
Paradox of wage flexibility (Galı́ and Monacelli, 2016)
I
Need more flexibility to generate more deflation and larger output gap
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
6 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Outline of Discussion
1
Brief summary and key findings
2
Decline of natural rate
3
Policy implications
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
7 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Level
Very low level of r ∗ throughout sample (1970-2016)
I
Compare with estimates from Holston, Laubach and Williams (2016)
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
8 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Level
Very low level of r ∗ throughout sample (1970-2016)
I
Large real interest rate gap since early 1980s?
Source: Justiniano and Primiceri (2010)
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
8 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
What Explains a Falling r ∗ ?
Major role of demographics and productivity growth
Government debt only factor that avoided much lower level
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
9 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
What Explains a Falling r ∗ ?
Some factors “disappear” from discussion
I
How would have r ∗ looked like without crisis?
I
Role of increased inequality?
I
Would be interesting to see counterfactuals with major driving forces
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
9 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Demographics and the Natural Real Rate
Carvalho, Ferrero and Nechio (2016) find similar role for demographics
I
Larger relative contribution of increase in life expectancy
Real Interest Rate
4.2
4
3.8
percentage points
3.6
3.4
3.2
3
2.8
2.6
2.4
1990
1993
1996
Baseline
Andrea Ferrero (Oxford)
1999
2002
Population Growth
2005
2008
2011
2014
Life Expectancy
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
10 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Demographics and the Natural Real Rate
Carvalho, Ferrero and Nechio (2016) find similar role for demographics
I
Larger relative contribution of increase in life expectancy
Main difference: In EMR, fixed lifetime horizon but decrease in mortality risk
I
Cannot live more than 81 years
Life expectancy currently at about 80 in most OECD countries
I
Increased over time and projected to keep increasing
I
Makes natural rate likely to keep falling
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
10 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Demographics and the Natural Real Rate
Carvalho, Ferrero and Nechio (2016) find similar role for demographics
I
Larger relative contribution of increase in life expectancy
Main difference: In EMR, fixed lifetime horizon but decrease in mortality risk
I
Cannot live more than 81 years
Life expectancy currently at about 80 in most OECD countries
I
Increased over time and projected to keep increasing
I
Makes natural rate likely to keep falling
Also, empirical consumption profile much less hump-shaped than in EFR
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
10 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Outline of Discussion
1
Brief summary and key findings
2
Decline of natural rate
3
Policy implications
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
11 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Policy Implications
Why is negative r ∗ a problem?
I
Zero lower bound
I
Bubbles and financial stability
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
12 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Policy Implications
Why is negative r ∗ a problem?
I
Zero lower bound: Level of r ∗ puts lower bound on π ∗
I
Bubbles and financial stability
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
12 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Policy Implications
Why is negative r ∗ a problem?
I
Zero lower bound: Level of r ∗ puts lower bound on π ∗
I
Bubbles and financial stability: Better raise r ∗ than increase π ∗
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
12 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Policy Implications
Why is negative r ∗ a problem?
I
Zero lower bound: Level of r ∗ puts lower bound on π ∗
I
Bubbles and financial stability: Better raise r ∗ than increase π ∗
Also, in this model, limited effects of forward guidance
I
What about quantitative easing?
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
12 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Policy Implications
Why is negative r ∗ a problem?
I
Zero lower bound: Level of r ∗ puts lower bound on π ∗
I
Bubbles and financial stability: Better raise r ∗ than increase π ∗
Also, in this model, limited effects of forward guidance
I
What about quantitative easing?
Implication: Expansionary fiscal policy
I
Debt/GDP from 118% to 215% raises r ∗ from -1.47% to +1%
I
But risk premia likely to rise
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
12 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Policy Implications
Why is negative r ∗ a problem?
I
Zero lower bound: Level of r ∗ puts lower bound on π ∗
I
Bubbles and financial stability: Better raise r ∗ than increase π ∗
Also, in this model, limited effects of forward guidance
I
What about quantitative easing?
Implication: Expansionary fiscal policy
I
Debt/GDP from 118% to 215% raises r ∗ from -1.47% to +1%
I
But risk premia likely to rise
Other policies options are challenging
I
Hard to increase fertility rates and productivity growth
I
Probably don’t want to increase mortality...
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
12 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Policy Implications
Why is negative r ∗ a problem?
I
Zero lower bound: Level of r ∗ puts lower bound on π ∗
I
Bubbles and financial stability: Better raise r ∗ than increase π ∗
Also, in this model, limited effects of forward guidance
I
What about quantitative easing?
Implication: Expansionary fiscal policy
I
Debt/GDP from 118% to 215% raises r ∗ from -1.47% to +1%
I
But risk premia likely to rise
Similar conclusions in Carvalho, Ferrero and Nechio (2016)
I
Additional option: Raise retirement age
I
But need increase well beyond currently contemplated reforms (OECD, 2010)
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
12 / 13
Introduction
Summary
Level & Decomposition
Policy
Conclusions
Conclusions
Very nice paper, definitely useful to think about current policy challenges
Decline in natural real interest rate product of
I
Financial crisis
I
Interacting with long-term trends
May still require some fine tuning on quantitative part
If Secular Stagnation is relevant scenario
I
Limited options for monetary policy?
I
Shift to more activist fiscal policy?
Andrea Ferrero (Oxford)
Discussion of Eggertsson, Mehrotra and Robbins
21 April 2017
13 / 13