Tuesday, 21 April 2020

Secular stagnation and the global surge in house prices

by Julius Probst

The decline in global real interest rates

Back in 2013, Larry Summers started to believe that most advanced economies have entered a new macroeconomic regime, a prolonged period of lower economic growth as a result of insufficient aggregate demand. In a recent piece, I argued that Summers' revival of the secular stagnation hypothesis has been the most important contribution to modern macroeconomics (Probst, 2019a). According to the secular stagnation theory, a combination of macroeconomic factors have pushed down real interest rates on a global level. These forces include adverse demographics, falling productivity growth, and rising inequality. With the decline in interest rates, Central Banks increasingly struggle to keep the economy at full employment because they cannot reduce interest rates substantially below zero. Therefore, many countries will also have a higher risk of experiencing recessions and might suffer from prolonged negative output gaps when interest rates remain constrained by the so-called effective lower bound (Summers, 2015; 2016).

The chart below displays the secular downward trend of real interest rates for the Japan, the US, the UK, and the Eurozone. Most other rich economies have suffered the same fate since the 1980s. A lot of economic research has shown that global interest rates have declined significantly and that they are nowadays at record-low levels across advanced economies since the late 19th century (Probst, 2019c, Schmelzing, 2017). Some economists have even suggested that current interest rates have never been that low throughout human history since the early Antiquity (Haldane, 2015). The decline in interest rates also had the unintended side-effect of pushing up the price of financial assets around the world, both stock markets and real estate.

Figure 1: Real Interest rates
CB policy rates minus CPI, 1 year MA

Source: Macrobond

The global surge in real estate prices

The second figure below shows that inflation-adjusted house prices have almost tripled across many advanced economies since the end of Bretton Woods in the early 1970s. This has especially been the case for Anglo-Saxon economies, but the social-democratic economies of Scandinavia have been severely affected as well. While increasing financialization and the globalization of capital flows probably also played their part in pushing up local real estate prices in global cities like London, New York, and Paris, etc., researchers at the Bank of England have argued that a significant part of the increase is due to the decline in global real interest rates. The reason is simple. The value of any financial asset is simply the net present value of all its future cash flows discounted at the rate of interest. As interest rates decline, future cash flows become more valuable and therefore the fundamental value of the financial asset increases.

Figure 2: Real house prices, Dallas Fed Price Index
Source: Macrobond

A standard way of pricing financial assets is by using the dividend discount model, according to which the net present value (NPV) of a financial asset is given by the sum of all future cash flows (R) discounted by the rate of interest (i):

While the formula is usually applied to stock prices, it is equally valid to use it for housing or other investments. As inflation-adjusted interest rates have declined significantly across the world in recent decades (and the same is true for nominal interest rates), the price of real estate and other financial assets increases as future cash flows are now discounted at a lower rate of interest. Halving the rate of interest would roughly correspond to a doubling of financial asset prices. It therefore stands to reason that the secular downward trend of interest rates has indeed contributed to a large extent to the spectacular surge in house prices across advanced economies.

Germany and Japan are the outliers

However, the researchers from the Bank of England might have gone one step too far in attributing almost the entirety of the increase in house prices to falling interest rates. Dwellings are after all not only a financial asset, but they also provide us with one of the most important services in life, namely housing. The demand for housing in large metropolitan areas has increased significantly in recent decades as most jobs high-income jobs have been created in the large agglomerations. The forces of economic geography have increasingly favored big cities since the 1990s while more rural regions have largely lost out (Florida, 2016). This has been the case in the US, but also in most European countries like Germany, the UK, and Sweden. Consequently, house prices have performed extremely different across regions within countries. Furthermore, there also seem to be vast differences internationally. While some countries have seen their house prices explode in recent decades, mostly a combination of stronger population growth and restricted supply, other countries have experienced a very different trend. Most noticeably, real house prices in Germany and Japan have stayed relatively flat for a longer time period (see below). Japan has seen stagnating house prices for more than 2 decades since the explosion of its asset price bubble in the early 1990s while Germany’s house prices have only started to catch up to the international trend very recently. This suggests that supply-side factors are also extremely important in determining house prices. According to the following statistic, the metropolitan area of Tokyo added more individual housing units in 2014 than the entire country of England. Consequently, house prices in Tokyo have experienced a very different trend than most other metropolitan areas around the world where supply has been much more constrained.

Figure 3: Real house prices, Dallas Fed Price Index. Germany and Japan
Source: Macrobond


Summing up, the evidence for secular stagnation seems to be increasing as advanced economies continue to suffer from even lower interest rates and economic growth rates than what was widely expected just a few years ago (Probst, 2019a; 2019b). Moreover, this does not seem to reverse any time soon as financial markets have priced in low interest rates for the foreseeable future. Secular stagnation also had the undesirable side-effect of bidding up house prices around the world as a result of low interest rates. However, the financial blog by the Bank of England might have somewhat overstated its case. Dwellings are not only a financial asset, but also a real commodity. While the entire advanced world has suffered from low interest rates during the last decade, supply-side constraints can explain why San Francisco or New York have experienced exploding house prices whereas this has not been the case in Tokyo, for example.

·         Florida, R. (2016). Winner-take-all urbanism: Geographic divisions in the modern era. Brown J. World Aff., 23, 103.
·         Gordon, M. J. (1962). The investment, financing, and valuation of the corporation. Homewood, IL: RD Irwin.
·         Haldane, A. (2015). Stuck. Bank of England Speeches.
·         Probst, J. (2019a). Lawrence Summers Deserves a Nobel Prize for Reviving the Theory of Secular Stagnation. Econ Journal Watch, 16(2), 342.
·         Probst, J. (2019b). Secular stagnation: it’s time to admit that Larry Summers was right about this global economic growth trap. The Conversation.
·         Probst, J. (2019c). Global real interest rate dynamics from the late 19th century to today. International Review of Economics & Finance, 59, 522-547.
·         Schmelzing, P. (2017). Eight Centuries of the Risk-Free Rate: Bond Market Reversals from the Venetians to the ‘VaR Shock’.
·         Summers, L. H. (2015). Demand side secular stagnation. American Economic Review, 105(5), 60-65.
·         Summers, L. H. (2016). The age of secular stagnation: What it is and what to do about it. Foreign Aff., 95, 2.

Julius Probst is a Customer Specialist at Macrobond Financial, a macroeconomic search engine and analysis tool and provider of financial time series data. Previously, he was a PhD student at the Economic History Department at Lund University and a PhD trainee at the ECB. He also has a blog on macroeconomics at macrothoughts.


  1. Secular stagnation along with stagflation was predicted in 1961. Stagflation came first because of the monetization of commercial bank time deposits, daily compounding of interest, etc.

    Once deposit classifications financial innovations reached its peak in 1981, the demand for money could no longer be satisfied by the remaining transactions deposits. And then the DIDMCA of March 31st drastically destroyed money velocity to boot.

    I.e., 15 trillion dollars in the U.S. payment's system are un-used and un-spent, lost to both consumption and investment, indeed to any type of payment or expenditure. Banks, from the standpoint of the economy, pay for their earning assets with new money -- not existing deposits.

    The 1966 Savings and Loan Association credit crunch is prima facie evidence.

  2. Another example:

    As I commented on 12-16-12, 01:50 PM #1 when the FDIC's unlimited transaction deposit insurance was reduced to $250,000:

    "We’re close to seeing the real power of OMOs. R-gDp is likely to accelerate earlier & faster than anyone now expects. The roc in M*Vt before any new stimulus is already above average.

    With low inflation (given some deficit resolution), Jan-Apr could be a zinger"

    Then we got the "taper tantrum" (in spite of budget sequestration in 2013, automatic spending cuts and subsequently above average R-gDp and N-gDp growth rates by putting savings back to work (by increasing money velocity).

    Zinger - a surprise, shock, or piece of electrifying news.
    So we had a "taper tantrum" and a temporary rise in gDp:

    01/1/2013 ,,,,, 4.4
    04/1/2013 ,,,,, 1.6
    07/1/2013 ,,,,, 5.1
    10/1/2013 ,,,,, 6.1
    01/1/2014 ,,,,, 0.7
    04/1/2014 ,,,,, 7.0
    07/1/2014 ,,,,, 7.1
    10/1/2014 ,,,,, 2.6
    01/1/2015 ,,,,, 3.2
    04/1/2015 ,,,,, 5.0

    That's called a "predictive success"

  3. Another example:

    As Luca Pacioli, a Renaissance man, "The Father of Accounting and Bookkeeping” famously quipped: (debits on the left and credits on the right, don’t go to sleep with an imbalance).

    And Leonardo Da Vinci said it best: “Before you make a general rule of this case, test it two or three times and observe whether the tests produce the same effects”.

    Prima Facie Evidence. The 2018 pivot:
    The interest-bearing character of the DFI’s deposits which result in any sudden larger proportion of commercial bank deposits in the interest-bearing category destroys money velocity.
    2018-11-05 0.49
    2018-11-12 0.49
    2018-11-19 0.56 [spike]
    2018-11-26 0.57
    This is also an excellent device for the banking system to reduce its aggregate profits (as all savings originate within the confines of the payment's system, and an individual bank's primary deposit is a derivative deposit - from a system's perspective).
    It is hard for the average person to believe that banks do not loan out savings or existing deposits – demand or time. But the DFIs always create money by making loans to, or buying securities from, the non-bank public.
    This results in a double-bind for the Fed (FOMC schizophrenia: Do I stop because inflation is increasing? Or do I go because R-gDp is falling?). If it pursues a rather restrictive monetary policy, e.g., QT, interest rates tend to rise.
    This places a damper on the creation of new money but, paradoxically drives existing money (savings) out of circulation into frozen deposits (un-used and un-spent, lost to both consumption and investment). In a twinkling, the economy begins to suffer.
    % Deposits vs. large CDs on "Assets and Liabilities of Commercial Banks in the United States - H.8"
    Jul ,,,,, 12227 ,,,,, 1638.6 ,,,,, 7.46
    Aug ,,,,, 12236 ,,,,, 1629.4 ,,,,, 7.51
    Sep ,,,,, 12268 ,,,,, 1662.4 ,,,,, 7.38
    Oct ,,,,, 12318 ,,,,, 1685.8 ,,,,, 7.31 (twinkling)
    Nov ,,,,, 12313 ,,,,, 1680.1 ,,,,, 7.33
    Dec ,,,,, 12425 ,,,,, 1698.6 ,,,,, 7.31
    Jan ,,,,, 12465 ,,,,, 1732.9 ,,,,, 7.19
    Feb ,,,,, 12494 ,,,,, 1744.6 ,,,,, 7.16

    See: Dr. Philip George - October 9, 2018: “At the moment, one can safely say that the Fed's plan for three more rate hikes in 2019 will not materialise. The US economy will go into a tailspin much before that.”

    Or you could look at the Calafia Beach Pundit: “money demand fell from mid-2017 to mid-2018 as confidence soared and the economy strengthened”

    Link: September 25, 2018: “An Emerging And Important Secular Trend”

  4. re: "many businesses are operating on a limited capacity or have ceased operations completely"

    Supports the stagflationary thesis: "Even Powell’s deputy commander — Vice Chairman Richard Clarida — recognizes the limits: The law of diminishing returns is a very powerful force in economics, and so we have to be concerned that it may also apply to quantitative easing."

    All you have to do is go back to the 1981 “time bomb”, the widespread introduction of ATS, NOW, SuperNow, and MMDA accounts. This regulatory action vastly accelerated the transactions velocity of funds (the non-neutrality of velocity), Vt, and therefore vastly accelerated aggregate monetary purchasing power, AD (a non-inflationary utilization of savings products).

    This release of savings, which were formally idled, formally frozen, propelled N-gNp to 19.1 percent in the 1st qtr. of 1981. See the progression in R-gDp:

    1979-10-01 1.0
    1980-01-01 1.3
    1980-04-01 -8.0
    1980-07-01 -0.5
    1980-10-01 7.7 *
    1981-01-01 8.1 *
    1981-04-01 -2.9 #

    • Represents the period in which Now accounts were unleashed, deregulated.
    • # represents the Fed imposing legal reserve requirements against Now accounts (abruptly decelerating Now’s impact).

    Compare that to the progression in inflation, implicit price deflator, during the same period:

    1979-10-01 7.6
    1980-01-01 8.7
    1980-04-01 9.9
    1980-07-01 9.2
    1980-10-01 10.8
    1981-01-01 11.0
    1981-04-01 8.2

    That’s called the non-neutrality of money, a fresh injection of un-used savings into the economy, propelling real output as opposed to stagflation. Powell essentially did the same thing on March 24th:

    “The regulatory limit in Regulation D was the basis for distinguishing between reservable "transaction accounts" and non-reservable "savings deposits." The Board's recent action reducing all reserve requirement ratios to zero has rendered this regulatory distinction unnecessary.”

    Even so, a second stimulus check is in order.

  5. Look up: “Should Commercial banks accept savings deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43.]

    Thus, as predicted In 1961, Princeton Professor Dr. Lester V. Chandler, Ph.D., Economics Yale, theoretical explanation was:

    “that monetary policy has as an objective a certain level of spending for gDp, and that a growth in time (savings) deposits involves a decrease in the demand for money balances, and that this shift will be reflected in an offsetting increase in the velocity of demand deposits, DDs.”

    Professor Chandler's conjecture was correct up until 1981 – up until the saturation of financial innovation for commercial bank deposit accounts (the “S-Curve” dynamic damage, sigmoid function, or the culmination in the “monetization” of time deposits by the first half of 1981, the near end of the “monetization” of time deposits, the virtual end of gate-keeping restrictions, Reg. Q ceilings, and reservable liabilities on time deposits).

    The saturation of DD Vt according to Dr. Marshall D. Ketchum, Ph.D. Chicago, Economics:

    1961: "It seems to be quite obvious that over time the “demand for money” cannot continue to shift to the left as people buildup their savings deposits; if it did, the time would come when there would be no demand for money at all”

    Thus, as Dr. Leland J. Pritchard, Ph.D. Chicago – Economics 1933, M.S Statistics, Syracuse predicted after the passage of (1) the DIDMCA of March 31st 1980, i.e., coinciding with his prediction of the (2) "time bomb", the widespread introduction of ATS, NOW, and MMDA accounts: that money velocity had reached a permanently high plateau.

    Professor emeritus Leland James Pritchard never minced his words, and in May 1980 pontificated that:

    “The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”.

    The deceleration in N-gDp was axiomatic:
    NSA N-gDp’s growth rates by decade, percent ∆:

    1970’s growth = 1.76
    1980’s growth = 1.15
    1990’s growth = 0.76
    2000’s growth = 0.52
    2010’s growth = 0.43

    Unless savings are activated, put back to work, a dampening economic impact, a deceleration in money velocity, is engendered and metastases, resulting in secular strangulation (not because of robotics, not because of demographics).

    As the economic syllogism posits:

    #1) “Savings require prompt utilization if the circuit flow of funds is to be maintained and deflationary effects avoided”…
    #2) ”The growth of commercial bank-held time “savings” deposits shrinks aggregate demand and therefore produces adverse effects on gDp”…
    #3) ”The stoppage in the flow of funds, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods.” Circa 1959