Morning Must-Read: Ashok Rao on the Intellectual Evolution of Larry Summers on the Possibility of a Long-Lasting Negative Real Natural Rate of Interest
This Is Ashok: The Evolution of Larry Summers: November 14, 2011, February 11, 2013, and November 8, 2013:
November 14, 2011: Munk Debate: “Be it resolved North America faces a Japan-style era of economic stagnation”:
Larry Summers: Paul, I would buy, not sell. You’re right that we will suffer needless unemployment and stagnation until more is done to address [our] demand deficiency…. My thesis is that as serious as [our] problem is, it is dimensionally much less than the problems that Japan faced…. Japan’s problems were different in magnitude, different in the depth of their structural roots, different in the relative perspective they had…] and different in the degree of resilience their system had for adapting to them…
Paul, you forecast in 1994… that Japanese potential GDP growth would be 3%[/year[ or a bit more. By that standard, Japan is now producing half of the potential output that people were forecasting when its lost decade began. That’s a problem of a different magnitude than a U.S. gap, serious though it is, at 6 or 7%. There is little wonder that Japan’s slow-down is so profound given the magnitude of the structural problems… the most rapidly aging society… epic insularity and inability to accept immigration; in the face of distress a massive retrenchment by its companies to their home markets; an utter lack of capacity for entrepreneurial innovation in the era of the social network. The United States remains, witness my colleague here, the only country in the world where you can raise your first 100 million dollars before you buy your first suit and tie….
The United States’ problems are the problems of every industrial democracy. And the U.S. share of the industrial world is steadily increasing. [I]f you look at what passes for governance in Europe in recent years, I would suggest that our problems do not loom large relative to either the economics or to the politics in the rest of the world. We remain totally unlike Japan. We remain the place where everyone in the world wants to come and the place where everyone in the world wants to put their money. Finally, we are a uniquely resilient society and we have seen this before. John Kennedy died believing that Russia would surpass the United States by the early 1980s. Every issue of the Harvard Business Review in 1991 proclaimed that the Cold War was over and that Japan and Germany had won…
February 11, 2013: World Economic Forum: “The Future of the American Public Sector”
Larry Summers: Look, I think people have counted the US out before. John Kennedy died believing that the Soviet Union would surpass the US by 1995…. People make that mistake now with respect to our economy and with respect to our politics. I think if we seize the moment we have huge and unique opportunity in the world. This is a moment for broad renewal that corrects all the deficits we have…. If we can in our public life, corporate life, and individual life turn our attention more to the future away from the present, this can be a profoundly important moment for the US….
In 1993… capital costs were really high. The trade deficit was really big…. Reducing capital costs and raising productivity growth was the right strategy. That was what Bob Rubin told Bill Clinton. That’s what Bill Clinton did. They were right. Today the long-term interest rate is negligible. The constraint is lack of demand. Productivity has vastly outstripped wage growth. And the syllogism “reduce the deficit and you’ll get more wages does not work the same way”….
Everyone in this room here was required to turn off their device in this room a couple of minutes ago. The device you were required to turn off had more power than the Apollo project, it has better access to information than the Library of Congress and in terms of reaching people around the planet, you would trade JFK’s communication system for your iPhone. And in 5 years from now 5 billion people will have it. So I don’t know how anyone can say we are making fundamental progress. The prophets of doom cannot have it both way. You cannot both say that the [robots are taking your jobs] and say nothing is happening that’s important for productivity growth…
November 8, 2013: The International Monetary Fund:
Larry Summers: There is I think another aspect of the situation that I think warrants our close attention that receives insufficient attention. The share of men, women, and adults that are working today is essentially the same as four years ago. Four years ago the financial panic had been arrested. TARP money had been paid back. Credit spreads had normalized. There was no panic in the air. That was a great achievement. But in those four years the share of adults who were working has not improved at all. GDP has fallen further behind potential as we would have defined it in the fall of 2009.
The American experience in this regard and this experience is not unique as RR has documented in the wake of a financial crisis. Japan’s real GDP today is about half of what we [the Washington Consensus] believed it would be. It is a central pillar of both classical and Keynesian models that it is all about fluctuations and what you need is less volatility. I wonder if a set of older ideas (that I have to say were pretty firmly rejected in [Stan’s class]) that went under the phrase secular stagnation that are now profoundly important in understanding Japan and may be relevant to the United States today….
If you go back and you study the economy prior to the crisis. There’s something a little bit odd. Many people believe monetary policy was too easy. Everybody agrees there was a vast amount of imprudent lending going on. Almost everyone agrees wealth as it was experienced by households was in excess of its reality. Too easy money, too much borrowing, too much wealth. Was there a boom? Growth was not high, unemployment was not too low, and inflation was quiescent. Somehow even a great bubble was not enough to create an excess in aggregate demand. Now think about after the crisis….
Suppose that the short term real interest rate that was consistent with full employment had fallen to negative 2 or negative 3 percent sometime in the middle of the last decade. Then what would happen? Even with artificial stimulus to demand coming from all this financial imprudence, you would not see any excess demand. And even with a relative resumption of normal credit conditions, you’d have a lot of difficulty getting back to full employment. Yes, it has been demonstrated that panics are terrible and that monetary policy can contain them when the interest rate is zero. It has been demonstrated less conclusively but presumptively that when short term interest rates are zero monetary policy can affect other asset prices to plausibly impact demand. But imagine a situation where natural and equilibrium interest rates have fallen significantly below zero. Then conventional macroeconomic thinking leaves us in a very serious problem….
This may all be madness and I may not have this right at all, but it does seem to me four years after the successful combating of crisis with no evidence of growth that is restoring equilibrium one has to be concerned about a policy agenda that is doing less with monetary policy than has been done before that is doing less with fiscal policy than has been done before and is taking steps whose basic purpose is for there to be less lending, borrowing than before. So my lesson from this crisis which the world has under-internalized is that it is not over until it is over, and that is not right now, and cannot be judged relative to the extent of financial panic. And, we may well need in the years ahead to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity holding our economies back holding us back from our potential.
About face.
Note, I am not accusing Summers of hypocrisy in this case. Too few intellectuals–especially those of this prestige–change their mind. I’d be thrilled to hear Summers detail the revision of his priors. That is always an interesting process…