One of the most significant changes in the world economy in the past couple of decades has been the decline in real interest rates and the commensurate rise in indebtedness:The chart above comes from a recent speech by Claudio Borio of the Bank for International Settlements. The question is why it happened.According to Larry Summers and other exponents of the “secular stagnation” hypothesis, the downward slope of the red line reflects deep changes in the balance between the supply and demand for credit. If market interest rates — and central banks — hadn’t responded to these underlying fundamental changes, the rich world would have been plagued with decades of underemployment and slow growth in the decades before the crisis.The corollary is that rich countries must either depend on continuously falling interest rates and continuously rising indebtedness to sustain spending, or address the underlying causes of the supply-demand imbalance. Interest rates can only fall so far, however, which might explain the inability of many rich countries to return to what had previously been considered “normal” after the crisis.Borio recognises the unsustainability of continuously falling interest rates, but wonders whether the “secular stagnation” explanation makes sense.
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One of the most significant changes in the world economy in the past couple of decades has...