Opinion

Lawrence Summers

It’s too soon to return to normal policies

By Lawrence Summers
March 26, 2012

Economic forecasters divide into two groups: those who cannot know the future but think they can, and those who recognize their inability to know the future. Shifts in the economy are rarely forecast and often not fully recognized until they have been under way for some time. So judgments about the U.S. economy have to be tentative. What can be said is that for the first time in five years a resumption of growth significantly above the economy’s potential now appears as a substantial possibility. Put differently, after years when the risks to the consensus modest-growth forecast were to the downside, they are now very much two-sided.

As winter turned to spring in 2010 and 2011, many observers thought they detected evidence that the economy had decisively turned, only to be disappointed a few months later. A variety of considerations suggest that this time may be different. Employment growth has been running well ahead of population growth. The stock market level is higher and its expected volatility lower than at any time since the crisis began in 2007, suggesting that the uncertainty hanging over business has declined. Consumers who have been deferring purchases of cars and other durable goods have created pent-up demand. The housing market seems to be stabilizing. For years now, the rate of family formation has been way below normal as young people moved in with their parents. At some point they will set out on their own, creating a virtuous circle of a stronger housing market, more family formation and demand, and further improvement in housing conditions. Innovation around mobile information technology, social networking and newly discovered oil and natural gas is likely, assuming appropriate regulatory policies, to drive significant investment and job creation.

True, the risks of high oil prices, further problems in Europe, and financial fallout from anxiety about future deficits remain salient. However, unlike in 2010 and 2011, it is probable that these risks are already priced into markets and factored into outlooks for consumer and business spending. There has already been a significant escalation in oil prices. The European situation is hardly resolved but is unlikely to deteriorate as much in the next months as it did last year. And market participants report great alarm about the deficit situation. So it would not take great news in any of these areas for them to actually contribute to upward revisions in current forecasts.

What are the implications for macroeconomic policy? Such recovery as we are enjoying is less a reflection of the natural resilience of the American economy than of the extraordinary steps that both fiscal and monetary policymakers have taken to offset private-sector deleveraging — a process that is far from complete. A convalescing patient who does not finish the full course of treatment takes a grave risk.  So too the most serious risk to recovery over the next several years is no longer the possibility of either financial strains or external shocks but that policy will shift too quickly away from maintaining adequate demand toward a concern with traditional fiscal and monetary prudence.

On even a pessimistic reading of the economy’s potential, unemployment remains 2 percentage points above normal levels; employment, 5 million jobs below potential; and GDP, close to $1 trillion short of potential. Even with the economy creating 300,000 jobs a month and growing at 4 percent, it would take several years to reattain normal conditions. So a lurch back this year toward the kind of policies that are appropriate in normal times would be quite premature.

Indeed, recent research on what economists label hysteresis effects suggests that slowing could have highly adverse consequences. Brad Delong and I argue in a recent paper that it is even possible that premature and excessive movements toward fiscal contraction by shrinking the economy risk exacerbating long-run budget problems.

How then to respond to valid concerns about fiscal sustainability, excessive credit creation and the eventual return to normality in a world where policy credibility is essential? The right approach is to pursue policies that commit to normalize conditions but only when certain thresholds are crossed. The Federal Reserve might commit to maintain the current Fed Funds rate until some threshold with respect to unemployment or expected inflation is crossed. Commitments to fund infrastructure over many years might include a financing mechanism such as a gasoline tax that would be triggered when some level of employment or output growth has been achieved. Tax reform could phase in new rates in pace with the rising economic performance.

Contingent commitments have the virtue of providing clarity to households and businesses as to how policy will play out, and in areas where legislation is necessary, eliminating political uncertainty. They allow policymakers to project a simultaneous commitment to near-term expansion and medium-term prudence — exactly what we require right now. An element of contingency in policy is always there in a volatile world. Recognizing it explicitly is the way to provide confidence and protect credibility in a world whose future no one can gauge with precision.

PHOTO: A help wanted sign hangs on the door of an Autozone shop in Golden, Colorado September 17, 2009. REUTERS/Rick Wilking

Comments
14 comments so far | RSS Comments RSS

I have to agree with Mr. Summers here. Luckily, constructive political discourse in Wahsington is at a standstill which fits nicely with his prescription.

We first need to fund infrastructure stimulus, reform the tax code and address some regulatory issues to reduce friction for business and job creation. Addressing our fiscal issues should be the next task, but what concerns me is that policy makers have not yet even come close to agreeing on a plan or even a general framework for a plan to address our fiscal imbalance.

It seems the timing would be just about right for Mitt to take office in early 2013 and begin to address these issues with some consensus.

Posted by jaham | Report as abusive
 

what an interesting job. first he puts our economy back into the stone age by repealing the Glass-Steagall act and now he gets paid to write about it. logic and debate are very detached from the thought that the author should be writing this story from anywhere but jail

Posted by billatl3 | Report as abusive
 

Lawrence, your article, “The stock market level is higher and its expected volatility lower than at any time since the crisis began in 2007, suggesting that the uncertainty hanging over business has declined.”

Permit me to ask you a question:

In any economy, if the Fed or central bank were to steadily and aggressively pump up the supply of money and credit, inflating a bubble as it is doing today, would that action not result in, or be manifested directly in, a steadily rising stock market that is eerily free of volatility, as it is today?

Posted by AdamSmith | Report as abusive
 

I must disagree with article.

Milton Friedman could have told us our policies were going to drive us over a cliff – In fact he did tell us.

Want a more modern example: Peter Ferrara has been shouting out loud for more than a decade.

The article is CORRECT is that there ARE two kinds of Economic forecasters:
- One type knows about cause and effect; and
- The other kind is like Lawrence Summers, and includes advisers to Bush and Obama.

Posted by flailer777 | Report as abusive
 

I must disagree with article.

Milton Friedman could have told us our policies were going to drive us over a cliff – In fact he did tell us.

Want a more modern example: Peter Ferrara has been shouting out loud for more than a decade.

The article is CORRECT is that there ARE two kinds of Economic forecasters:
- One type knows about cause and effect; and
- The other kind is like Lawrence Summers, and includes advisers to Bush and Obama.

Posted by flailer777 | Report as abusive
 

Lawrence Summers, I would have certainly thought of you as a Goldman Republican, but from your article, I can see that you are not. A true Republican would be screaming Austerity, Austerity, Austerity! at the top of his lungs from the very onset of the economic decline all the way up to and beyond this point in time. Congratulations. I don’t think you’re a Democrat because your actions label you as a total elitist, but at least you’re not a Republican ideologue beliving in the confidence fairy, trickle down economics, the Laffer Curve, and other such widely held nonsense. These 50% (or whatever huge number they are) are like persons being strangled to death while others can see that the person is in fact strangling his own self.

Posted by snippityp | Report as abusive
 

USA “private-sector deleveraging” that’s the crux thats been talked about for years and years in our media, but it’s a globalized phenomenon to. Most average humans around the world are flat broke. Mega comapnies rush to control the remaining natural resources. Muppets? Yes, we are controlled by strings. “Extraordinary monitary policy” will run out before the deleveraging finishes Mr. Summers, then what? Pitchforks and torches? but hey, you got yours right?

Posted by Jonesy | Report as abusive
 

Larry Summers is wrong as usual, but I would not expect otherwise , since saying current policies are wrong would mean accepting blame for them in the first place as much that is not working is the result of policies he helped put in place.

Summers is a little vague here, but he does broach the topic of excessive credit creation(ZIRP?). The Fed’s policy taxes savers and transfers wealth to the big banks and promotes mis-allocations of capital.

What has this policy delivered? Right now it appears the Fed has succeeded in manipulating the stock market.
The mechanism is the low rates that permit companies to borrow huge amounts of money to pay dividends or buy-back stock which reduces float and makes earnings per-share look better than it otherwise be. In short companies are responding to Larry Summer’s preferred environment with financial engineering of the balance sheet.

And the rise in stock prices is good headline news that the pundits on CNBC and the like, due to their inability to dig deeper, will use to say the economy is doing better. It’s also important to realize that higher stock prices do not create the same wealth to investors as a rise in rates does in that those benefiting from higher stock prices is a smaller group than those who rely on fixed income investments. This is true when looking at the breadth and scope of investments across all demographic groups.

Posted by VonMisses | Report as abusive
 

An inflation target of 5+ percent is the unwritten policy of the Fed and our government. Without inflation, the only viable way to reduce the debt is through spending cuts and or increased taxation. As we’ve seen in Europe, this can negatively affect a recovering economy. The Fed will continue to ease as they see fit hoping that our meager growth rate continues and that, at some point, prices begin to rise.

Posted by gordo53 | Report as abusive
 

Why does anyone listen to this turkey?

Posted by El_Monstro | Report as abusive
 

You state “Economic forecasters divide into two groups: those who cannot know the future but think they can, and those who recognize their inability to know the future.”

From the tone of this article you apparently belong to the first group.

Posted by PseudoTurtle | Report as abusive
 

A good way to test the bias of a forecaster is to see what he does when he knows the future.

Let’s take a look at what Mr Summers recommends when he “Knows” the economy in advance. It’s exactly what the Obama 2013 budget is all about.

If we have 10 years of 5% GDP growth (a major assumption Obama’s budget), here is his plan.

From Obama’s 2013 Budget and the Printing Office.

2008 Spending = $3 trillion
2012 Spending = $3.8 trillion (27% more)
2022 Spending = $5.1 trillion

Add 5% GDP growth compounded for 10 years (~65% total growth) and they recommend.

Double taxes
2008 receipts = 2.5 trillion
2022 receipts = 5.1 trillion

More than double Debt
2012 debt = $9.2 trillion
2022 debt = $23 trillion

Every man woman and child owes the federal government $80,000 in 2022. We clearly don’t have any nest egg if the economy goes south in 2022. Oh, I forgot, that’s our children’s problem and my man is no longer in office.

Maybe Mr. Summers needs to re-read Keynes and stop believing his overly complicated rhetoric.

Posted by Tarthur | Report as abusive
 

Dr Summers wrote in the Financial times Nov 23 2007 that we were in a recession. Those who heeded were saved. Thank you sir

Posted by nickko | Report as abusive
 

Summers helped promote the repeal of Glass-Stegall provisions that led to the financial collapse. He’s all about keeping the hedge fund managers and the CEOs of Wall Street happy. Why should we listen to him after seeing how those policies tanked our economy? If the advice of Krugman and Stiglitz, rather than that of Summers, had been sought by Obama we’d likely be in a much better position today.

Posted by yogahelps2 | Report as abusive
 

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