Larry Summers’ New Model: Details, Contradictions, And Odd Assumptions

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

44 thoughts on “Larry Summers’ New Model: Details, Contradictions, And Odd Assumptions

  1. We’ve come up with a standard doctrine (deficit spending with lower taxes) towards the intervention of recessions. What if our blind acceptance of the solution is leading us down the wrong path? What if studying the great depression/Japan/etc. for answers is actually the wrong thing to do because where we are now is so fundamentally different that a new treatment plan needs to be developed. It seems crazy to think that the same things that got us in this mess (low interest rates, deficit spending) are now the very cure. Maybe that’s the illogic of it all, we’re trying to restart the economy when actually we need to be fundamentally rebuilding.

  2. The most appealing path will be the one that creates actual sustainable jobs, and the one where economic advisors don’t collect millions from advising hedge funds and “analysis” shops.

    Larry Summers, nephew to both Ken Arrow and Paul Samuelson. Ken Arrow, friend of Abt Associates and a founding member of the Pontifical Academy of Social Sciences. Paul Samuelson, spiritual father of Stanley Fisher, Lawrence Klein, and Robert Merton (who helped Black and Scholes break the world… and who sat on the board of LTCM and who subsequently went into business with some interesting people).

    Abt Associates, society’s best friend. “The Company applies its expertise in research, consulting, technical assistance, data collection and medical and life sciences to a wide variety of problems in the public and private sectors. In the United States, Abt Associates has helped shape many important and complex public programs, including Medicaid, welfare reform, Head Start, crime reporting, and housing experiments. The Company is also a recognized leader in providing technical assistance to facilitate policy reforms in countries moving to market oriented economies.”

    Sorry, too much coffee, too much anger.

  3. “[D]oes his model really offer the most plausible or appealing path from here to there?”

    Simple answers to simple questions:


    * * *

    Then again, we might ask “plausible or appealing” to whom, eh?

  4. Reality continues to embarrass ol’ Larry. “Brilliant” Larry ideas have failed miserably in this critical time. So maybe the One should appoint him Fed Chairman like ol’ Larry seems to want?

    Even his fellow Clinton Administration economist Robert Reich thinks the recovery under Larry’s tutelage is a long way off.

  5. Uncle Billy’s name dropping is right on target.

    It still seems staggering that the musings of a bunch of academics cobbling together some basic statistics and misguided notions about rational men and utility curves etc. could have conned as many people as they have.
    You don’t think they really believed all that MPT stuff.. or perhaps they did

  6. I argue that the United States has outsourced a great deal of its manufacturing and R&D to China and some other nations over the last ten to fifteen years. The United States is living off a subsidy in the form of physical goods and some services (e.g. software development) from China and some other nations. This probably involves draining resources out of China’s rural areas and is not sustainable, and simply not in China’s interests. It also means that a fiscal stimulus may tend to result in the purchase of goods from China and some other nations, who so far tend to sit on the IOU’s from the US, thus blunting the expected multiplier effect.

    At some point, China will pull the plug, revalue the yuan, and retool their industry to produce goods and services for their own nation. This will cause inflation and all kinds of problems in the United States and further blunt the effects of any fiscal or monetary stimulus.

    It seems doubtful that Larry Summers and other policy makers have thought the implications of the United States heavy dependence on manufacturing and some R&D in China and other nations through.

    I have written on this in more detail in “Why a Fiscal Stimulus May Fail and What To Do”

    Click to access why.pdf

    This article is written for a general audience that may not be familiar with Keynesian economics.



  7. I’m not a big fan of the British press. Here the FT break bread with Larry Summers in a puff piece where they spend more time describing the walls, what they’re eating, and what color tie he’s wearing than asking him questions about financial reform (or the lack thereof). If I need a narration of Larry Summers eating lunch I’ll search for his wife’s mobile number. Maybe next time they can make a podcast of the bastard eating corn chips. Just as useful.

  8. I thought the problem at hand is deflation. Green shoots gone brown so worrying about inflation is premature. This is correct: “there has been a permanent shock … 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.”, but the timing is wrong at least until the green shoots stay green for a while.

  9. Go, Uncle Billy! But you left Andrei Schliefer out of the litany. Have another cup of coffee and stop pulling your punches.

    We do appear to have developed a mandarinate that would have done the Middle Kingdom proud. I think it is a mandarinate rather than an oligarchy, and ours is brilliant, learned, sophisticated and inwardly focused. Not sure they are the crowd to lead us into a palatable future, but they will most certainly enjoy a pleasurable present for themselves, and ‘we’ probably aren’t in this together.

  10. Summers 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.”

    Question: Where does tax reform fit into this equation?

  11. The deeply corrupt Summers of course believes whatever will sell his current policy ideas and, generally, the people who he believes matter. We have a problem of governance, here in the USA: we seem incapable of putting competent people in high economic offices, and incapable of removing incompetents. We also seem incapable of electing a majority of Senators who are not reactionary conservatives. WtF?

  12. Very interesting. How curious that, among thelist of long-term goals,LS omits any mention of fiscal consolidation. He and the Administration have really soft pedalled on fiscal discipline–I believe this will prove to have been a mistake with costs to be paid in the bubble next time.

  13. I’m not a Summer’s fan but when he lists long-term issues of paramount importance “like fixing health-care, like having real energy policy, like reforming education” he is merely doing the job that he signed on to do, i.e., economically justify his boss’ agenda. You are basically criticizing him for being willing to do that job.

    What is there in Larry Summers’ history that makes anyone expect anything else of him?

  14. Just give me another bubble, and fix the student loan system while you’re at it, so I can go to graduate school without worrying about everything!

    Thank you,
    Ed Beaugard

  15. Simon is much too kind to lay the entire blame for our completely screwed up economic policies on Larry. David Zetland and I have published a detailed description of what has gone wrong, what should be done about it, who was responsible (Larry had a lot of help-read Goldman Sachs), and what likely comes next. You can read it at, and it is available as a Kindle book. We are not nearly as polite as Simon. We hope you enjoy our book and we welcome your comments at

  16. Unfortunately, Larry has signed onto the Lifetime Plutocracy Membership Plan. Ergo, all his ideas are intended to be hints in that direction. Either that, or he has early onset dementia!! As a result of bought and sold policy wonks (Tim and Larry to name just a couple), all of the good ideas are getting mired in policy-speak (i.e. single payer health care, flat tax, take over of the too-big-to-live financial institutions, public campaign financing, decriminalization of illegal drugs, meaningful action on climate change, etc., etc., etc.). This is a disease which has been make long acting and undefeatable by the moneyed oligarchs represented by the high-powered lobbies who can derail every good idea, even if they have to get proponents jailed (i.e. single-payer advocates).

    If our President stands for change, I am beginniing to believe that even with the substantial public support that he could rally, he is refusing to press forward, and truly take the case for reform to the public. When is he going to get rid of Summers and replace him with Simon Johnson? OOH, things could get really ugly with real reform at hand.

    I am truly sorry that this country has outsourced its intellect, along with everything else. I don’t know if taxpayers are ready for a permanent economic malaise punctuated by ever more tragic downturns. I really wonder how much longer we can affort to do things like Afghanistan. Every tax dollar needs to count these days, and so the budget lines in the near and far term are going to have to be closely scrutinized. Why are we arguing about the continuation of Bernanke’s term? He really seems to be, with Christine Romer, and Peter Orzag, one of the truly sane and sensible public servants left.

    I can’t tell you, in the storm over whether Republicans can find meaning and cohesion, whether the Democrats really only seem to have their stuff together. Congress has definitely lost its way, and Summers is the last guy we should be considering to be worth considering – ever – at all!!!!

  17. You needn’t be shy or esoteric. Mandarinate, oligarchy? Horse fadoopus! We’ve crossed over the precipice into the abyss of fascism with all of its earmarks readily in evidence. One needs look past the all too obvious connections between lobbying interests and the whorehouse that is Congress to the consequences: The state capitalism, an American version of the Nazi-Thyssen/Krupp/Farben arrangement except with the names changed to Bank Of America/Citibank/Goldman Sachs/General Motors/Chrysler, to the willingness to lie our way into wars of aggression, to aid and to abet so-called allies engaged in ethnic cleansing, to torture, to trample wantonly upon the rights of American citizens in the name of national security. Whereas in 1930s Germany the governnment stripped Jews of their property so as to enrich “aryan” businesses, this time we’re the dispossessed Jews and, in exactly the same way, the friends of the ruling clique are the ones being enriched. And anyone stupid enough to believe that they’re going to vote their way out of this one – frankly, those stupid enough to vote at all – will deserve the price of their naivete.

  18. With a corrupt Congress on both sides of the aisle beholden to the interest groups that have the last say on any legislation that benefits them and by inference not the public at large, the President is doomed unless he makes a new course direction to strangle the oligarchs.

  19. And to illustrate the dispossession referred to above, just consider who the recipients of California’s IOUs have been and who California’s cash in that state’s continuing crisis:

    Note that its not the little people of California that get the cash. Hell no, its the filth that run and administer the government and the legal system. Want crystal clarity on the pattern that would be apt to emerge should a similar fate befall the federal government? Look no further.

  20. Larry Summers joins his mentor Robert Rubin in having been wrong about ever aspect of the American economy’s deformation and what needs to be done about it. The duo are also exceptional in their ability to have distorted actively the behavior of the federal government and financial institutions they either led or advised. To be included in this indictment is their blase disregard of the gross upward redistribution of the wealth created by the national economy for the past 35 years. Without correcting that imbalance, a major drag on the economy will remain in place.

    To place Summers, and his thinking on this issue, in perspective, I draw your attention to an op=ed piece he wrote for the FT on December 6 2006. I commented on it at the time this way:

    There, he vents his keen anxiety that the (admitted) income gap could lead to populist pressure to take unenlightened government action. In this category of unwanted changes he places “changes to the rate structure” of taxes. What does he
    offer? An end to audit “disproportionately the tax returns of those in the bottom half of the income distribution.” Marie Antoinette couldn’t have put it
    any better; in fact she didn’t. He rejects out of hand anything that doesn’t “go with the grain of the market system.” (That included the now shamefully collapsed financial markets). Wasn’t that the argument in the 1930s against the New Deal? Who decides how that grain runs and what will dislocate it? Plus ca change…

    Michael Brenner

  21. Don’t forget Larry Summers 1998 role in shooting down CFTC’s Broksley Born request to regulate the CDS market. He wrote her a letter stating that if she regulated the CDS market she would destroy our economy. Well look who is now running the the US economy. I couldn’t think of a more unqualified buffoon for the job. Tu Ne Cede Malis Sed Contra Audentior Ito.

  22. How about reworking our ecomony to optimize lives not wealth? We’ve let the tail wag the dog. What we need are jobs that suit our people not our sales projections. If some tycoon can make a fortune doing that, they deserve riches and praise to boot.

  23. Mr. Johnson:You rightly mention our well-established current account deficit and huge foreign debt as one of the differences between the U.S.’s position and Japan’s. Yes, and it’s one of the most-overlooked issues that we should deal with now instead of another stimulus package with more foreign borrowing. Several years ago Warren Buffett wrote in Fortune that “Our trade deficits are selling America out from under us.” He said “We need to fix it now,and here’s how to do it.” That led to a proposed Senate Bill S3899 “The Balanced Trade Restoration Act of 2006”. It didn’t pass then because the economy seemed O.K. But look at us now! Buffett’s plan for issuing tradable import certificates equal to our exports is market-based and doesn’t target any industry or country. It would quickly create manufacturing jobs, reduce our foreign debt, and wouldn’t add to the current budget deficit.Wake up Washington!!! K.N.Davis, Jr
    Former U.S. Assistant Secretary of Commerce/International

  24. Yes and so with this crisis we cannot afford to do all the much more important than assisting banks things we should be doing now.

    And all this, no matter what is said, is not the result of excessive risk-taking but of the pure and misguided excessive risk-aversion of the regulators who tempted the world to pour massive resources in that world of safe assets (houses) in a safe country, (USA) and in “risk-free” instruments (AAAs).

    Can we please have some of our healthy human developing risk-taking back? Or could someone at least take away these stupid risk-aversion regulations that only extremely gullible and innocent regulators could have concocted. Boy, talk about the nerds really being nerds.

  25. Summers is just another Democratic Party machine sycophants who are ottally incompetent. Can you image a Clinton devotee so crass that he was run out of Harvard?

    The Dems have absolutely no idea of what our economy is about because no small business people are Dems.

    America may be unable to recover from the damage being done my the Messiah and his irrelevant henchmen.

    The stimulus package is nothing but a massive illegal payoff to Obama’s supporters and is having the effect of prolonging the recession.

  26. You hit the nail on the head. There is only so much money and we know where it all is, Wall Street. We also know who’s being paid off to keep it that way, our elected officials. A few million citizens camping around the Capital building would change that. Blogging is like masterbation, it offers some relief but just doesn’t get the job done.

  27. There are no Messiahs nor Darth Vaders, just some fairly frail humans who once in power cannot get beyond the limits of their ideology. As we sink into another trough, I agree with the first question: why do we persist in our deficit/lower taxes response to recessions? This sounds like the logic of an addiction. Just a little more spending and some tax relief and I’ll be okay.

    Blaming an oligarchy (which I quite agree is what we have) doesn’t solve the problem. We need that alternate vision that Simon refers to in his piece on Upton Sinclair.

    Politically, Obama ran on a vague notion of change that sometimes in his speeches peaks out, but I suspect that whatever that fuller vision is, he fears it is too radical to fly politically.

    Problem: without a compelling political vision that substantially restructures the relationship between government and the people, much as Lincoln did at Gettysburg and Roosevelt with the New Deal, there is no significant recovery. Instead we will plod along like a character from a 19th century novel dying from tuberculosis, the flush high spirit and rosey cheeks mask the progression of a fatal disease.

  28. Next time it won’t be the levees of New Orleans that break. It will be the Financial levees of America. Obama!! …..Obama!! ….. are you listening Obama!!!!! General Zod (Goldman Sachs) is here! MAYDAY!!! SOS!!!

  29. ^^^ double click the upper part of the above picture to watch. Are the guys at the White House drunk on apples and M&Ms???? Ask Brian Williams of NBC—he’s on the job 24/7. No M&M candy or apple will join the CIA wiretaps without Brian Williams approval.

  30. This song is dedicated to the 2 times divorced, 3 wives super hypocrite, Catholic dude named Newt Gingrich.

  31. Senator Boehner’s cab won’t pick up Obama?? What’s up with that??? Senator Boehner doesn’t like Sotomayer either???

    George Wallace owned the taxi company??? Hmmmmm……

  32. Well with respect to “humanity at its sordid worst” he is at least surpassed by he who feels he should express his opinions to the world using such a disgraceful pseudonym as Lavrentia Beria
    It is disrespect to all of us!

  33. The pseudonym, Lavrenti Beria, was apparently not quite sufficiently “disgraceful” to prevent a full reading of the comment’s text by you, eh, Mr. Above-It-All. You remind me of the hypocritical judge who just has to review the pornographic film to determine whether or not its filthy. In the future you can spare us the phony, self-serving outrage.

  34. Aw, now have we’ve gone and offended your carefully nurtured sensibilities, young lady?

  35. I do not feel above it all but that does not mean I have to be below it all.

    Now if you feel it is an honor to express your opinions under that pseudonym, that’s your right but just the same my right is to feel no qualms to self serve myself objecting this.

    Daddy daddy what did my grandfather opine? Son, go to the web and look up Lavrentia Beria.

  36. “I do not feel above it all …”

    Sure you don’t, chief, you just keep believing that. To be charitable, let’s just say you virtually define the word, supercilious.

    “… but that does not mean I have to be below it all.”

    Well now of course you don’t, little fella, but with that noxious whiff of arrogance you’re giving off, I’d say that somehow you’ve managed to pull it off, eh?

    “Son, go to the web and look up Lavrentia Beria.”

    Now I promise not to tell anybody if, while doing your research, you find it necessary to look up the meaning of the word, supercilious. I haven’t got the slightest doubt that you’ll need to. :-)

  37. Yeah, but the real Lavrenti Beria wouldn’t be such a schmendrick as to spell the word incorrectly.

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