Why Are Interest Rates So Low, Part 3 - The Global Savings Glut - Brookings Institution

9/15/2015
Why are interest rates so low, part 3: The Global Savings Glut | Brookings Institution
Why are interest rates so low, part 3:

The Global Savings Glut
My previous post[1]discussed Larry Summers secular stagnation

hypothesis[2], the notion that monetary policy will be chronically
unable to push interest rates low enough to achieve full employment.
The only sure way to get closer to full employment, in this view, is
through fiscal action.
A shortcoming of the secular stagnation hypothesis is that it focuses
only on factors affecting domestic capital formation and domestic
household spending. But US households and firms can also invest
abroad, where many of the factors cited by secular stagnationists (such
as slowing population growth) may be less relevant. Currently, many
major economies are in cyclically weak positions, so that foreign
investment opportunities for US households and firms are limited. But
unless the whole world is in the grip of secular stagnation, at some
point attractive investment opportunities abroad will reappear.
If thats so, then any tendency to secular stagnation in the US alone
should be mitigated or eliminated by foreign investment and trade.
Profitable foreign investments generate capital income (and thus
spending) at home; and the associated capital outflows should weaken
the dollar, promoting exports. At least in principle, foreign investment
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and strong export performance can compensate for weak demand at

home. Of course, there are barriers to the international flow of capital
or goods that may prevent profitable foreign investments from being
made. But if thats so, then we should include the lowering or
elimination of those barriers as a potentially useful antidote to secular
stagnation in the US.
Some years ago I discussed the macroeconomic implications[3] of global
flows of saving and investment[4] under the rubric of the global
savings glut. My conclusion was that a global excess of desired saving
over desired investment, emanating in large part from China and other
Asian emerging market economies and oil producers like Saudi Arabia,
was a major reason for low global interest rates. I argued that the flow
of global saving into the United States helped to explain the
conundrum (to use Alan Greenspans term[5]) of persistently low
longer-term interest rates in the mid-2000s while the Fed was raising
short-term rates. Strong capital inflows also pushed up the value of the
dollar and helped create the very large US trade deficit of the time,
nearly 6 percent of US gross domestic product in 2006. The diversion of
6 percent of domestic demand to imports provides an alternative
explanation to secular stagnation for the failure of the US economy to
overheat in the early 2000s, despite the presence of a growing bubble
in housing (see Hamilton, Harris, Hatzius, and West (2015)[6] for a
quantitative analysis).
There is some similarity between the global saving glut and secular
stagnation ideas: Both posit an excess of desired saving over desired
capital investment at normal interest rates, implying substantial
downward pressure on market rates. Both can account for slower US
growth: Secular stagnation works through reduced domestic investment
and consumption, the global savings glut through weaker exports and a
larger trade deficit. However, there are important differences as well. As
Ive mentioned, the savings glut hypothesis takes a global perspective
while the secular stagnation approach is usually applied to individual
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countries or regions. A second difference is that stagnationists tend to

attribute weakness in capital investment to fundamental factors, like
slow population growth, the low capital needs of many new industries,
and the declining relative price of capital. In contrast, with a few
exceptions, the savings glut hypothesis attributes the excess of desired
saving over desired investment to government policy decisions, such as
the concerted efforts of the Asian EMEs to reduce borrowing and build
international reserves after the Asian financial crisis of the late 1990s.
This second difference is important, I think, because it implies quite
different policy responses, depending on which hypothesis one accepts.
As Summers has proposed, if secular stagnation is the reason for slow
growth and low interest rates, expansionary fiscal policy could be
helpful; and, in the longer run, the government could also take steps to
improve the returns to capital investment, such as offering more
favorable tax treatment and supporting research and development. If a
global savings glut is the cause, then the right response is to try to
reverse the various policies that generate the savings glutfor example,
working to free up international capital flows and to reduce
interventions in foreign exchange markets for the purpose of gaining
trade advantage.
To help assess whether a global savings glut still exists, the table at the
end of this post updates the data from my 2005 and 2007 speeches.
Shown are national current account surpluses and deficits for four
years, two before and two after the crisis, with the most recent being
2013 (complete data for 2014 are not yet available). The data, mostly
from the International Monetary Fund, are in billions of U.S. dollars.
Expressing current account balances in dollars allows for easy
comparisons across countries, but keep in mind that the figures are not
adjusted for inflation or growth in the various economies and regions.
A countrys current account surplus is roughly the net amount of
financial capital it is sending abroad; its also equal to the countrys
national saving less its investment at home. A country with a current
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account surplus is saving more than it is investing domestically and

using the excess savings to acquire foreign assets. A country with a
current account deficit is a net borrower on global capital markets.
The table confirms a few basic points about the evolution of current
account balances:
First, the US current account deficit roughly halved (in dollar terms)
between 2006 and 2013, falling to about $400 billion, or 2-1/2 percent
of gross domestic product. Of course, the upsurge in US oil production,
which reduced the need for imported energy, had a lot to do with that.
Among the major industrial countries, the improvement in the US
position was partly offset, arithmetically speaking, by a significant
decline in Japans current account surplus and Canadas sharp swing
into deficit.
Second, the aggregate current account surplus of emerging market
countrieswhose large net saving was an important part of my original
savings glut storyhas fallen significantly since 2006. The decline is
accounted for by the reduction in Chinas surplus (partly offset by
increases elsewhere in Asia) and a shift from surplus to significant
deficit in Latin America (particularly in Brazil).
Third, the current account surplus of the Mideast/North Africa region
was large in 2006 and remained large in 2013, reflecting continued
profits from oil sales. However, given the sharp recent drop in oil prices,
it seems likely that those surpluses fell in 2014.
Finally, in an important development, the collective current account
surplus of the euro zone countries has risen by more than $300 billion
since 2006. About a quarter of this swing comes from increases in
Germanys already large surplus, but the dominant factor is the shift
from deep deficit to surplus on the part of the so-called periphery
(Greece, Ireland, Italy, Portugal, Spain). Some of that may be due to
improvements in competitiveness, but the bulk likely reflects the deep
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recessions those economies have experienced, which have reduced

domestic investment opportunities.
What should we conclude? The interpretation of the data below can
only be impressionistic, but here is my take. An important source of the
global saving glut I identified before the financial crisis was the excess
savings of emerging market economies (especially Asia) and of oil
producers. The good news is that, for reasons ranging from Chinas
efforts to reduce its dependence on exports to the decline in global oil
prices, the current account surpluses of this group of countries, though
still large, look to be on a downward trend. Offsetting this decline,
however, has been a significant increase in the collective current
account balance of the euro zone. In particular, Germany, with
population and GDP each less than a quarter that of the United States,
has become the worlds largest net exporter of both goods and financial
capital. In a world that is short aggregate demand, the persistence of a
large German current account surplus is troubling. However, much of
the net change in the euro zone balance in recent years appears to be
due to cyclical factorsspecifically, the deep ongoing recession in the
European periphery.
Putting all this together, the global savings glut hypothesis remains a
useful perspective for understanding recent developments, particularly
the low level of global interest rates. Overall, I see the savings glut
interpretation of current events as providing a bit more reason for
optimism than the stagnationist perspective. If (1) China continues to
move away from export dependence toward greater reliance on
domestic demand, (2) the buildup of foreign reserves among emerging
markets, especially in Asia, continues to slow, and (3) oil prices remain
low, then we can expect the excess savings from emerging markets and
oil producers to decline further from pre-crisis peaks. This drop has
recently been partially offset by the movement of the euro zone into
current account surplus. However, only part of the rise in the European
surplusmostly the part attributable to Germanylooks to be
structural and long-lasting. Much of the rest of euro-zone surplus likely
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reflects depressed cyclical conditions. When the European periphery

returns to growth, which presumably will happen at some point, the
collective surplus ought to decline.
If global imbalances in trade and financial flows do moderate over time,
there should be some tendency for global real interest rates to rise, and
for US growth to look more sustainable as the outlook for exports
improves. To make sure that this happens, the US and the international
community should continue to oppose national policies that promote
large, persistent current account surpluses and to work toward an
international system that delivers better balance in trade and capital
flows.
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Sources: IMF World Economic Outlook database; national sources; U.S.

Bureau of Economic Analysis, Department of Commerce. Advanced
Economies includes G10, Euro Area (which is calculated as the sum of
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the 18 countries), and the Other Advanced Economies (as defined by

the IMF, but excluding the Asian tigers).
Comments are now closed for this post.
Links
1. http://www.brookings.edu/blogs/ben-bernanke/posts/2015/03/31why-interest-rates-low-secular-stagnation
2. http://larrysummers.com/wp-content/uploads/2014/06/NABEspeech-Lawrence-H.-Summers1.pdf
3. http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/
4. http://www.federalreserve.gov/newsevents/speech/bernanke20070911a.htm
5. http://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm
6. http://econweb.ucsd.edu/~jhamilto/USMPF_2015.pdf
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9/15/2015

Why are interest rates so low, part 3:

My previous post[1]discussed Larry Summers secular stagnation

and strong export performance can compensate for weak demand at

countries or regions. A second difference is that stagnationists tend to

account surplus is saving more than it is investing domestically and

recessions those economies have experienced, which have reduced

reflects depressed cyclical conditions. When the European periphery

Sources: IMF World Economic Outlook database; national sources; U.S.

the 18 countries), and the Other Advanced Economies (as defined by

Get a free Evernote account to save this

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