Bernanke-Summers Debate II: Savings glut, investment shortfall, or Monty Python?

from Steve Keen

A Twitter follower accused me of being “a little nasty” with my last blog post. He was right, and I don’t apologize.

I’ve spent 40 years trying to highlight just how limited the dominant ideas in economics are. But even I didn’t fully appreciate how tiny the intellectual gene pool behind these ideas was.

Then, as I started to write a post on the economic issues in the Bernanke-Summers debate, I re-read Summers’ original secular stagnation post and realized that, not merely were the ideas coming from a single perspective, most of the major proponents of these ideas came not only from the same University (MIT), and even the same seminar (Class 14462, conducted by Stanley Fisher).

Think of the dominant names in economics and there are a few obvious entries: Ben Bernanke; Larry Summers; Paul Krugman; Olivier Blanchard; Ken Rogoff. Summers acknowledged all of them (bar Krugman) as classmates from Stanley Fisher’s seminar, while Krugman did his PhD at MIT (as did the other dominant macro textbook author—and ex-advisor to George W. Bush and Mitt Romney—Gregory Mankiw). 

This goes well beyond the dominance of economics by a single school of thought, and I felt that “in-breeding” was a nasty but evocatively accurate way to express just how narrow the so-called “economic debate” had become—and therefore how justified were student calls for pluralism in economics. Hell, we don’t simply need pluralism: we need to hear opinions from people who didn’t attend Stanley Fisher’s lectures. Maybe being nasty about this might get people to realize why economics needs to change.

To see how inbred this Bernanke-Summers debate really is, let’s look at the explanations they’re putting forward for the persistently disappointing growth rates being experienced around the world—even in countries that, like America, can now claim to have recovered from the financial crisis of 2007. Bernanke is blaming a “savings glut”, and directs the blame at savers in countries like China:

My conclusion was that a global excess of desired saving over desired investment, emanating in large part from China and other Asian emerging market economies and oil producers like Saudi Arabia, was a major reason for low global interest rates. (Bernanke in “Why are interest rates so low, part 3: The Global Savings Glut”)

Summers, on the other hand, argued that there is a secular decline in the level of investment, coming from a number of long-term factors, including lower population growth, lower rates of technical progress, and rising inequality:

Slower population and possibly technological growth means a reduction in the demand for new capital goods… Rising inequality operates to raise the share of income going to those with a lower propensity to spend… (Summers in “Reflections on the ‘New Secular Stagnation Hypothesis’”.

One sign that these two views are coming from the same mindset is that they can both be represented using the same diagram: the “Loanable Funds” model of the supply of savings as a function of the rate of interest, and of the demand for savings (investment) also as a function of the rate of interest, where the intersection of the two lines gives you savings and investment at full employment. In this model, the ideal world is the one shown Figure 2: the supply of savings and the demand for it to fund investment projects can be reconciled at a positive interest rate.

Figure 1: The Loanable Funds model

Bernanke’s explanation for why we are in a prolonged slump involves shifting the Savings line out to the right—to represent the “global savings glut”. Summers’ explanation involves shifting the investment curve in to the left—to indicate a shortage of profitable investment opportunities. So what they are arguing is whether, in terms of this model, the blue demand (investment) or the red supply (savings) curve has shifted as shown in Figure 3, and if so what to do about it?

Figure 2: Bernanke vs Summers on the same diagram

Now there are empirical data that you can trot out to support each of these arguments, as Summers and Bernanke duly do. But what if the main factor causing slow growth rates—and low or negative interest rates—has nothing to do with this model? Then it won’t even get a look-in in their analysis, even if there happens to be strong data supporting it, because both Summers and Bernanke suffer from what Daniel Kahneman has called “theory-induced blindness”: the inability to see data that contradicts their underlying theory.

This is not a criticism of Bernanke or Summers as people, nor even of economics in general: Kahneman himself says that he suffers from it:

The mystery is how a conception that is vulnerable to such obvious counterexamples survived for so long. I can explain it only by a weakness of the scholarly mind that I have often observed in myself. I call it theory-induced blindness: Once you have accepted a theory, it is extraordinarily difficult to notice its flaws. As the psychologist Daniel Gilbert has observed, disbelieving is hard work. (Daniel Kahneman, “Bias, Blindness and How We Truly Think (Part 2)”)
The danger in economics is that Bernanke and Summers and the vast majority of influential economics share the same theory. This is crucial. If they all had theory-induced blindness, but some espoused different underlying theories to others, then at least we would get a range of blindspots to compare: some would not see what others did, and vice versa. To borrow from Monty Python, we could consider “something completely different”. Empirical research could then determine which theory was better (because its blindspots were less dangerous than its rivals). But in economics that doesn’t happen, because the Neoclassical-New Keynesian-MIT consensus is the only theory espoused.

For instance, the final figure in this post shows a very strong relationship between the US unemployment rate and another unidentified economic variable. Neither Bernanke nor Summers would consider this as a candidate for explaining low interest rates and low growth rates after the crisis however, because the unidentified economic variable in Figure 4 doesn’t fit into their model.

Figure 3: An empirical relationship neither Bernanke nor Summers see

I’ll explain this “something completely different”, and why Bernanke and Summers and all the graduates of Stanley Fisher’s class 14462 can’t see it, in my next post.