Larry Summers had “lunch with the FT” (p.3 in the Life and Arts section today) – although unfortunately the paper does not report when this happened; a week or two makes quite a difference these days.
Putting this next to his April speech to the IDB, Summers’ view of the way forward has a few problems.
Summers says “The American problem this time has more in common, at least qualitatively, with the Japanese post-bubble problem, where the issue was not reassuring foreigners but maintaining sufficient domestic demand to push the economy forward.”
But Japan had a chronic current account surplus, which became bigger as firms saved more in order to pay down their debts during the 1990s. The Japanese government could finance its deficit domestically – and the country exported capital consistently. In contrast, with our well-established and large current account deficit and our eye-popping budget deficit, we rely much more on the confidence of foreigners – unless Summers is assuming that the increase in our private sector savings will be truly enormous.
As Summers says, quite accurately, the Asian and other crises of the late 1990s,
“… took the form of a foreign lack of confidence in a country that led to a mass withdrawal of funds and made reassuring foreigners the central priority. That’s why interest rates often had to be increased.”
Surely, we face some sort of hybrid Japan/emerging market crisis. Or perhaps we are heading towards blending Japan in the 1990s and the US in the 1970s, i.e., there has been a permanent shock (oil then v. financial sector now) to which we should adjust, and if we attempt to postpone that adjustment excessively through overexpansionary macro policies, we’ll experience a great deal of inflation.
On Japan in the 1990s, Summers is famous for first arguing it was an aggregate demand problem and later coming to the view that the banks were undercapitalized and – without this – the economy could not sustain a recovery. His ideas on the US are likely to go through the same evolution.
It is also striking that he makes no mention of balance sheets problems, either for consumers or businesses – in Japan then or the US now. It sounds like he is getting ready to push for a second fiscal stimulus – actually, for him this would be the third stimulus, as he argued hard for the tax cut stimulus of early 2008.
Summers is almost certainly wrong when he says, “The very great enthusiasm for accumulating reserves that one saw globally is likely to be a smaller factor over the next decade than it has been in recent years.” On the contrary, most emerging markets are glad they had more reserves than in the past and are now wondering about how to build up those reserves further. This may, of couse, help the US sell some of its forthcoming government debt – but it doesn’t reduce “global imbalances” or address the fact that we are on an unsustainable public debt and foreign debt path. Most of all, it lets us dig a deeper hole for ourselves and for the world economy.
More broadly, Summers continues to argue, at least implicitly, that we face a temporary shock or one-off aberration of some kind. He distinguishes sharply “fixing” the banking system and “getting the economy out of the rut” from long-run issues, “like fixing health-care, like having real energy policy, like reforming education.” He apparently does not see much by way of connections between these two sets of issues.
But doesn’t the economic and political power of our troubled banking system threaten our longer run opportunities? Aren’t our nonfinancial reform options (e.g., on universal healthcare coverage) already limited by the doubling of government debt (towards 80% of GDP) we are undertaking as a direct consequence of financial sector misfeasance? And won’t Medicare – and much else – be undermined by the behavior of “too big to fail” banks down the road?
Summers has commendably switched some of his rhetoric, so now he emphasizes nonfinancial technology development – presumably in the private sector – as the road to sustainable growth. And he rightly contrasts this with the financial engineering that brought us to this point. But does his model really offer the most plausible or appealing path from here to there?
By Simon Johnson