Speaking during a Statec event on Friday, Harenberg presented his white paper on “Stagnation in the Eurozone”. The findings extend the work of Gauti Eggertsson, Neil Mehrotra and Jacob Robbins--which used a New-Keynesian framework but introduced an overlapping generations structure to it--and apply the model to the eurozone.
Harenberg concluded that the eurozone is indeed in secular stagnation due to several forces producing a “perfect storm to push interest rates to zero.”
Among the most important force at work is a lower fertility rate--and the changes required to get interest rates to return to normal are “daunting”, according to Harenberg, who adds: “We estimate that the total fertility rate would need to go from its current value of 1.5 to 1.8 for real interest rates to rise to -1%.”
Looking at the macro drivers in the breakdown of real neutral interest rates between 2008-18, which in total decreased by 8.7 percentage points (pp), Harenberg explains that 44% of this could be attributed to changes in fertility (-3.9pp), seconded only by mortality accounting for 40% (-3.5pp). As a comparison, productivity as a driver accounted for 23% of this overall change (-2.0 pp).
The fall in fertility, says Harenberg, “means that there are fewer young households around. And typically young households are those who ask for loans to finance consumption, their cars, housing,” which contributes to the neutral interest rate--the short-term interest rate that would prevail with equilibrium (i.e., stable inflation, full employment)--being depressed.
Moreover, he argues, the aging population and other forces contribute to an oversupply of savings--the so-called “savings glut”.
Longevity is in fact the second of the nine most important secular forces studied by Harenberg. As he explains: “Longevity means the middle-aged need to save more for retirement, adding to the supply of lendable funds, further depressing rates. In addition, the shrinking labour force means, at least for a while, a relative abundance of capital..."
“As a result, the marginal product of capital falls, reducing equity returns, which makes some investors shift funds from equities to bonds, depressing interest rates. Hence, demographic change deals a triple whammy to interest rates.”
Impact on fiscal policy
Fiscal policy is one area which could make a real impact over the short-term. Government debt is a variable somewhat within the EU’s grasp, Harenberg argues, and therefore it’s interesting to note that his model shows that this would need to “rise permanently from roughly 89% of eurozone GDP in 2018 to 112% of GDP for a -1% real interest rate and to close to around 153% for a 1% real rate.”
Yet one measure which could be promising in the model is increasing the retirement age, which “would seem very efficient because it not only reduces the amounts needed to be saved for retirement, hence raising the neutral rate, but it also supports aggregate demand.”
Ultimately, the European Central Bank “needs to get back into a position where it can fight the next economic shock,” while there is still work to be done to fully understand the consequences of the covid-19 pandemic.