Home > The Economics Profession > Larry Summers joins the reality-based economics community

Larry Summers joins the reality-based economics community

from Dean Baker

In a remarkable departure from earlier versions of Larry Summers, the former Treasury secretary, Harvard president and top Obama economics adviser has recently been sounding the alarm about “secular stagnation” — a prolonged period of time in which the economy operates below its potential level of output. This discovery may provoke choruses of “duh” from the tens of millions of workers who for years have had the opportunity to live with secular stagnation in the form of unemployment, underemployment or stagnant wages.

But even if Summers’ discovery is not news to most people, it is a huge development nonetheless. Summers is one of the world’s most prominent economists. In the mainstream of the profession it has long been a matter of virtual absolute faith that the economy will tend to sustain full employment levels of output. Any departures from full employment will be quickly corrected by the self-adjusting market, ideally with a helping push from a reduction in interest rates by central banks.

This view seems less credible in the wake of the recession that began more than six years ago. By the estimates of the Congressional Budget Office the economy is still operating at a level of output that is more than six percent below potential GDP, corresponding to a loss in output on the order of $1 trillion a year. The economy is still down more than 8 million jobs from its trend growth path.  And the jobs report released on Friday certainly doesn’t raise hopes we will be closing this gap any time soon. 

Clearly this has not been a quick recovery. Furthermore, with the short-term interest rate at near zero for the last five years, it is not very clear what else the Fed or other central banks can do to spur growth. To Summers’ credit he is able to look at this situation and change his views about the economy.

This is striking given how much he is associated with the policies that got us here in the first place. After all, Summers held top positions in President Bill Clinton’s Treasury as it pushed its policy of deregulating the financial sector. Summers was at the forefront of those arguing that the financial industry would be more efficient without government regulators constantly looking over their shoulders. As late as the summer of 2005 he derided as “Luddites” those who questioned the wisdom of giving the financial sector free rein.

Summers also seemed just fine with asset bubbles back in the 1990s as the economy rode the stock bubble to four years of strong growth at the end of the decade. He also didn’t seem to mind large trade deficits. He continued the high dollar policy, put in place by his predecessor, which was the main cause of the explosion in the size of the deficit at the end of the 1990s and the start of the last decade.

In short, Larry Summers’ fingerprints are all over the policies that gave us the housing bubble, the financial crisis and the Great Recession. While there is no reason to forgive him for extremely costly mistakes that would be career-ending in other lines of work, there is also no reason not to welcome Summers’ entrance into the world of reality-based economics. Secular stagnation and its manifestations is in fact the greatest economic problem faced by the United States and other wealthy countries.

If Summers deserves credit for recognizing the problem, he still could use some work on his solutions. The line being pushed by Summers is that we need a large dose off public investment, which can boost demand in the short-run and potential output in the long-run. This is of course true, but as Summers should know given his past positions, fiscal stimulus does not appear to be a very easy sell politically. This means that if we want to get back to full employment we may have to look in other directions.

The one currently being pursued to a limited extent by the Fed and other central banks is extraordinary monetary policy such as quantitative easing, in which the Fed buys up long-term government bonds or mortgage-backed securities. This policy is intended to directly lower long-term interest rates and to raise the inflation rate. In the case of Japan, the latter goal is quite explicit.

At a recent panel of the American Economic Association, Summers dismissed the prospects for this approach and warned of dangerous bubbles developing if countries go this route. When one of his co-panelists suggested that bubbles could be reined in with effective macro-prudential policies, such as restricting the flow of credit markets identified as having bubbles, Summers dismissed the idea. He was skeptical that central banks could identify and attack bubbles before they become dangerous to the economy. This was a puzzling claim, since bubbles that are big enough to damage the economy are not hard to see.

Summers also dismissed the idea that developing countries may switch back from running trade surpluses with the advanced countries to again running trade deficits, leading to large increases in demand in the advanced countries. While he claimed that such a shift was implausible, developing country trade surpluses have already been sharply reduced. In the case of China, its trade balance went from a surplus of 10.1 percent of GDP in 2007 to just 2.5 percent last year.

Finally, we could go the route of work sharing that Germany has used with great success (its unemployment rate is 5.2 percent). Under such a policy, companies avoid layoffs and the government burden of unemployment benefits by keeping employees but making them work fewer hours. If we can’t increase the amount of demand in the economy, we can at least divide the work so that fewer workers must endure the hardship of unemployment. Summers has also been dismissive of this approach.

In embracing the secular stagnation view, Summers is rejecting the religious faith in a self-correcting market that still dominates the mainstream of the profession. While we all should welcome this important convert, he might try a more ecumenical approach to policy from within his new framework. In what I like to call the reality-based economics community, the main goal must be to get people back to work. It is less crucial that it be done through any important person’s chosen route.

See article on original website

  1. January 16, 2014 at 3:53 pm

    Glad to see this discussed. Herman Daly wrote about this recently, and we honored him on the Wall of Fame at Growth Bias Busted: http://www.growthbiasbusted.org/wall-of-fame/entry/the-negative-natural-interest-rate-and-uneconomic-growth

    Dave Gardner
    Director of the documentary
    GrowthBusters: Hooked on Growth

  2. Paul Davidson
    January 16, 2014 at 4:24 pm

    Work sharing is nonsense — it is merely to get your unemployment statistic from looking bad and sharing unemployment with other workers who would otherwise be fully employed.! Why force leisure on workers who prefer to work and earn more income??

  3. Paul Davidson
    January 16, 2014 at 4:31 pm

    Near zero interest rates is a two way sword. On the one hand it may encourage some investment spending — but since investment spending depends on “animal spirits” more than a rational calculation of future returns relative to the interest rate costs of current borrowing.– do not expect too much from Fed QE! On the other hand with a significant portion of the population being seniors and retired and living off retirement income and investments — low interest rates reduces the income of such retired rentiers and therefore reduces consumption spending of many senior households — therefore reducing total aggregate demand ! Think what this does to entrepreneurs’ animal spirits — especially of entrepreneurial firms that produce goods and services aimed at seniors.

  4. January 16, 2014 at 5:43 pm

    If Larry Summers changes his point of view and joins this club, he will find that his degree of influence on the system will rapidly shrink towards Zero.
    The system is predatory and needs a priesthood to justify its predation. It is not looking for rebels to point out its true nature.

  5. Charlie
    January 17, 2014 at 9:27 pm

    i don’t trust him or his opinion about any particular economic issue, signed ‘one senior’ He has taken the wrong side of economic issues for so long one shift in his point of view still leaves him in the group up for the Dynamite Prize for Economics

  6. January 18, 2014 at 3:33 pm

    Sometimes I wonder what neoclaccisicts think the purpose of an economist is. First they claim that whatever prices and quantities the market yields are tautologically the right ones. Whatever behaviour the economy exhibits is also the right behaviour, or if not there’s no valid action to influence it anyway so don’t ask. But I do ask why did you become an economist then? Oh I forget, there’s no purpose to a neoclassical economist. The market just yields them.

  7. January 19, 2014 at 9:13 am

    I’m with Herman Daly and Dave Gardner on this.

    GDP growth is not a good solution to either cyclical or structural unemployment.

    The only good solution to unemployment is the restoration (and by relatively labour-intensive technologies, to boot) of such ecosystems as can be restored with any modicum of thermodynamic efficiency and without negative impact on biodiversity. Part of the solution to the unpleasant social consequences of unemployment is get people who can afford to, to accept more leisure, and to find innovative ways to get sufficient calories of sustenance and adequate shelter to people who are currently under-nourished, inadequately housed or otherwise impoverished due to unemployment, without having to pay them to destroy any more of the few, still functional natural ecosystems we have.

    In the long run, a slower rate of growth in the labour force, and the substitution of less-ecologically harmful technologies for the more harmful ones we are currently using, would also help a great deal.

    I think we should seriously explore the idea of greater public spending on contracts with small-scale entrepreneurs to restore clean up cities and restore ecosystems, financed, not by printing more money, nor by public borrowing, but by a consumption tax on selected consumers, those who exceed certain, relatively high, wealth or income thresholds. Wealthy consumers who are potentially exposed to the tax, would, under this type of scheme, be able to substantially mitigate the incidence of the tax on themelves, by investing privately, in suitable ecosystem restoration projects. Private sector ecosystem restoration projects however, would need to be audited for thermodynamic and biodiversity integrity, by a public agency, before the associated tax credits would be granted for application against the consumption tax liabilities of these private investors.

    Michael Barkusky
    Pacific Institute for Ecological Economics
    Vancouver BC

  8. January 19, 2014 at 9:24 pm

    Michael, While I appreciate your concern, the missing assessment of the colossal role played by massive fraud & corruption in the perversion and demise of the global economy and the host biosphere would seem laughable if it were not so pitiable. The catastrophic nuclear industry, oil industry, war industry, the strategic deception of “acceptable risk” and the Free Market (among other ecocidal delusions) are not much more daunting than the reality of the growth of automation induced job-loss approximately equalling the global birth rate and export of job opportunities to the lowest-wage economies. In other words, without a deeply fundamental paradigm shift to a completely new paradigm that rewards creativity and education and healthy recreation as prime values while “punishing” ecocidal, anti-healthy, anti-creative, anti-sustainable personal pursuits & cultural activities, the predominant “World Game” (Plutocracy/demonocracy) and its “economy” are self-doomed. Hence, conventional utilitarian faux-solutions for symptoms will not cure The Cause. For more on The Cause, see: literature on the 7 Deadly Sins, Tao Te Ching, the Lotus Sutra, etc. Good Luck. Sincerely

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