Must-Read: Larry Summers: A Remarkable Financial Moment

Must-Read: Larry Summers: A Remarkable Financial Moment: “10 and 30 year interest rates today reached all time low levels of 1.32 percent and 2.10 percent…

…Record low 10 year interest rate were also registered in Germany, France, Switzerland and Australia.  Notably Swiss 50 year interest rates are now for the first time negative.  Rates out 15 years are negative in Germany and 9 years in France. Such rates would have seemed inconceivable a decade ago and very unlikely even a couple of years ago…. Extraordinarily low rates reflect both subtarget expected inflation even over long horizons and very low real interest rates…. Remarkably the market does not now expect a full Fed tightening until early 2019. This is despite all the Fed speeches expressing optimism about the economy and a desire to normalize interest rates… very low long term real rates, sluggish growth expectations, concerns about the ability even over the fairly long term to get inflation to average 2 percent, and a sense that the Fed and the world’s major central banks will not be able to normalize financial conditions in the foreseeable future….

Policymakers still have not made sufficiently radical adjustments in their world view to reflect this new reality of a world where generating adequate nominal GDP growth is likely to be the primary macroeconomic policy challenge for the next decade. Having the right world view is essential if there is to be a chance of making the right decisions.  Here are the necessary adjustments…. Neutral real interest rates are likely close to zero going forward…. Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation…. Evidence from markets and some surveys suggests that inflation expectations are becoming unhinged to the downside…. In a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded…. The conditions Brad Delong and I set out in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.

Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment…. In the presence of chronic excess supply structural reform has the risk of spurring disinflation rather than the contributing to a necessary increase in inflation. There is in fact a case for strengthening entitlement benefits so as to promote current demand…. Traditional OECD-type recommendations cannot be right as both a response to inflationary pressures and deflationary pressures.  They were more right historically than they are today…. Treatments without accurate diagnosis have little chance success.  We need to begin with a much clearer diagnosis of our current malaise than policymakers have today.  The level of interest rates provides a very strong clue.