A Contagious Malady? Open Economy Dimensions of Secular Stagnation

This paper by Gauti Eggertsston, Neil Mehrotra, Sanjay Singh, and Larry Summers was released yesterday as an NBER Working paper. The paper looks at secular stagnation in open economy and examines how it is transmitted across countries (in an OLG framework with many countries and imperfect capital integration). One interesting implication is that if the Fed pursues an interest rate hike, and the rest of the world does not follow, we should expect strong capital flows into the US thus possibly generating a mismatch between desired savings and investment. This, in turn, leads to a drop in the US natural rate of interest forcing the Fed to cut rates again to avoid a recession:

A Contagious Malady? Open Economy Dimensions of Secular Stagnation, by Gauti B. Eggertsson, Neil R. Mehrotra, Sanjay R. Singh, Lawrence H. Summers, NBER Working Paper No. 22299: Conditions of secular stagnation - low interest rates, below target inflation, and sluggish output growth - characterize much of the global economy. We consider an overlapping generations, open economy model of secular stagnation, and examine the effect of capital flows on the transmission of stagnation. In a world with a low natural rate of interest, greater capital integration transmits recessions across countries as opposed to lower interest rates. In a global secular stagnation, expansionary fiscal policy carries positive spillovers implying gains from coordination, and fiscal policy is self-financing. Expansionary monetary policy, by contrast, is beggar-thy-neighbor with output gains in one country coming at the expense of the other. Similarly, we find that competitiveness policies including structural labor market reforms or neomercantilist trade policies are also beggar-thy-neighbor in a global secular stagnation.

A related variation that strips down the argument in the paper (which uses and elaborate DSGE model) into a simple textbook IS-MP framework is in this year's AER Papers and Proceedings volume. The results are much the same. See here. The more elaborate model should give people comfort in knowing that the key insights hold once you put add all the bells and whistles of a modern DSGE (or perhaps it's the other way around).