To see Mr Summers' point, think back to before the crisis. Long-term real interest rates then were trending downwards in the US and UK. This should in theory have unleashed a general economic boom as companies took advantage of low interest rates to invest more. But it didn't. The boom was largely confined to the housing market. As Mr Summers says, US unemployment "wasn't remarkably low" before the crisis and inflation was "entirely quiescent". The same was true in the UK. Unemployment rose in 2006-07, to over 5 per cent on the narrow official measure, and although inflation rose in 2007-08 this was largely due to higher oil prices rather than to the generalised inflation associated with excess demand. All this suggests that low interest rates before the crisis weren't sufficient to achieve full employment. Low as they were, rates were still above their equilibrium level - the level necessary to get the economy working at its full potential.
But why was this equilibrium rate so low? It's because the desired level of saving increased after the 1990s. This created an incipient savings glut, which forced down equilibrium interest rates.
One source of excess savings came from Asia, and especially China. The region ran large current account surpluses in the 00s. Such surpluses - by definition - mean that their savings exceeded their domestic investment. This put downward pressure on interest rates. We can put this another way. A current account surplus also means - again by definition - that a region is supplying more goods and services than it's demanding. This tends to depress aggregate demand and employment, which requires lower real interest rates to maintain a given level of economic activity.
The second source comes from nearer home. After 2002, non-financial companies became net savers. Between 1987 and 2001, companies retained profits tended to equal their capital spending; they were neither borrowers nor lenders. Sure, in boom years they borrowed to finance high investment, but in slack years they paid the debt off. Net, they were neither lenders nor borrowers over the long run. However, after 2002 investment fell relative to retained profits, and companies saved more and more. This reflects the dearth of investment opportunities described by Fed chairman Ben Bernanke in a famous speech in 2005, which in turn was due in part to the slower technical progress described by Robert Gordon at Northwestern University and George Mason University's Tyler Cowen.
So, real interest rates were falling even before the crisis. But the crisis might have exacerbated the trend, in at least four ways:
■ Banks' reluctance or inability to lend means the potential supply of credit - and hence economic activity - has slowed. Just as the boom in credit supply in the early 1980 raised real interest rates - as tight monetary policy was necessary to rein in a credit-fulled expansion - so a lesser supply now requires a looser monetary policy and lower real interest rates to kick the economy into action.
■ Households have reduced their expectations for future incomes, and so reduced borrowing. Despite the talk of a housing bubble, the stock of mortgage debt has grown only 0.9 per cent in the last 12 months, compared to over 10 per cent in 2006-07.
■ Companies' increased pessimism has led them to step up their savings. In the last 12 months, non-financial firms' capital spending was equivalent to only 74 per cent of their retained profits - even less than before the crisis.
■ The eurozone crisis has added to global desired savings. Southern Europe is trying to reduce its government and overseas borrowing, while the North isn't greatly reducing its saving. This is putting downward pressure on economic activity and interest rates.
All this poses the question which is especially acute for those of us a few years from retirement: what could reverse these trends and so raise equilibrium interest rates?
There are plenty of things here we just can’t know. For example, it’s impossible to say whether the pace of technical progress will pick up or not; if it does, real interest rates will rise, but nobody can predict this.
What we can say, though, is that history tells us that growth slowdowns have usually been only temporary in the past. Andrew Sentence, a former MPC member and author of Rediscovering Growth, points out that economists talked of stagnation in the 70s, but this didn’t prevent growth returning in the 80s. There are at least three reasons to hope for a repeat of this.
First, the Chinese economy will gradually rebalance towards more consumer spending and less exporting. As its current account surplus shrinks, so will one force behind global excess supply and the savings glut.
Secondly, one reason for the negative yield on index-linked gilts is simply that investors are still unusually risk-averse, and so have high demand for assets they consider to be safe. As memories of the crisis recede and growth returns - however modest - such risk aversion should fade. This is already happening. Since March, 10-year index-linked yields have risen by a full percentage point. It’s no accident that this has coincided with a pick-up in growth.
Thirdly, there's the possibility of policy changes. The most obvious way for growth and real interest rates to rise would be for fiscal austerity to end. But anything that encourages investment and borrowing would have the same effect.
You might think all these are mere hopes. But the market shares them. The fact that the index-linked yield curve is upward-sloping means that investors expect real rates to rise. The market is pricing in ten year real yields rising from minus 0.3 per cent now to plus 1.3 per cent in ten years’ time. If it’s right, then we 50-somethings might enjoy a slightly more comfortable retirement than we'd get now.
