New Paradigm?

Since the U.S. election, I’ve been trying to make up my mind about whether so-called Trumponomics could spell the beginning of a “new paradigm” of stronger growth, higher inflation and higher natural interest rates, and thus spell the end of PIMCO’s New Normal and The New Neutral, Larry Summers’ Secular Stagnation or Ben Bernanke’s Global Savings Glut. Pick your favorite label for what had become the consensus view (more than) priced into financial markets over the past year or two. I’m still of two minds about this, and we will surely debate the issues at our upcoming December Cyclical Forum, but with markets having started to romance the new paradigm, here are my preliminary thoughts.

Framework is everything, so let’s go back to the one I described a little over a year ago in my Macro Perspectives, “ No End to the Savings Glut.” I used the term “savings glut” as short code for a situation where the world’s desired (ex ante) saving exceeds the desired investment. Excess global savings have depressed demand, inflation and the natural interest rate, which is the theoretical level of rates that equilibrates saving and investment ex post. Ex ante saving is high mainly because of demographics (rising longevity makes people save more for old age), rising inequality (the rich save more than the poor) and large emerging market (EM) current account surpluses, which have reflected a mix of export-led development models and a lack of domestic safe assets. Ex ante investment and thus the demand for savings is low mainly because of technology and the rising share of services in overall output, both of which imply less of a need and thus less demand for capital goods.

In that piece, I also used the results of an important study by two Bank of England economists that quantifies the impact of desired saving, desired investment and other factors on the secular decline in world real interest rates. This isn’t easy, because desired saving and investment cannot be directly observed and the estimates are therefore highly uncertain. In a nutshell, the authors estimate that of the 450 basis point (bp) decline in world real interest rates since the 1980s, about 100 basis points was due to lower potential growth, some 300 basis points was due to changes in desired saving and investment and only the remaining 50 basis points remains unexplained. Figure 1 offers a bit more detail on the relative importance of the factors explaining the secular decline in interest rates.

So how would Trumponomics, defined as a combination of lower personal and corporate tax rates, higher infrastructure spending, curbs on immigration and more protectionist trade policies, affect these secular drivers of low interest rates? In all of this, keep in mind that the sources of the savings glut are global and that the U.S. accounts for only 25% of world GDP.