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In a new speech at the IMF Economic Forum, Larry Summers said the US may be in a near-permanent slump -- an assertion Peter Coy calls “deeply pessimistic”. What the US faces, Summers warns, is secular stagnation. The problem: nominal interest rates can’t go any lower, because they’re already near the zero lower bound, but the economy may need real interest rates of negative two or three percent to get back to full employment. Here’s Summers:
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, below their potential.
Paul Krugman is annoyed, because he agrees with Summers, and “Larry’s formulation is much clearer and more forceful, and altogether better, than anything I’ve done”. The US economy, repeats Krugman, still needs good old-fashioned Keynesian policy like burying gold in coal mines or faking an alien attack.
The most radical part of Summers’ speech, Krugman says, is his assertion that we may need very negative real interest rates (that is, interest rates after accounting for inflation) to kickstart growth. When real interest rates go negative, monetary policy becomes less effective, says Krugman. Summers adds that rates can stay low, but QE can’t go on indefinitely, even if the economic conditions that make it necessary continue forever. If that’s true, says Krugman, “we may be an economy that needs bubbles just to achieve something near full employment”.