Secular Stagnation Hiccup

The Scary Debate Over Secular Stagnation Hiccup . . . or Endgame? by j. bradford delong

The first principle of success in practically any endeavor is to move not toward where the ball is, but where it is going to be. Economists, as a rule, ignore this principle, indulging in the likely-to-be-vain hope that Tpolicies that would have worked yesterday

will still work tomorrow. tk

34 The Milken Institute Review tk

Fourth Quarter 2015 35 secular stagnation I have been losing arguments with him since But now there is hope that economists will I was 20. What’s needed here, though, is not a do better, a hope based on the near-consen- referee’s decision, but a guide to the fight. sus that the modes of thought of the past two The immediate macroeconomic problem generations are obsolete. Ben Bernanke, the is how to cure the hangover from the housing former Federal Reserve chairman, says we bubble in the middle of the first decade of the have entered an age of a “global savings glut.” 21st century – the still-incomplete recovery in Kenneth Rogoff of Harvard points to the the United States and the non-recovery in Eu- emergence of global “debt supercycles.” Prince rope. But even a straightforward success that ton’s Paul Krugman warns of the return of restored the growth rate experienced in the “Depression economics.” And former Treasury 1990s would not restore the world as we Secretary Lawrence Summers calls for broad thought we knew it. Do we also suffer from Bernanke’s Without governments willing to global savings glut, produced by ill- deal with the structural problems, we are doomed to oscillate between asset bubbles and depression. coordinated national policies toward structural shifts in government policy to deal recovery? His prescription is reform that with “secular stagnation.” gives governments better incentives to pull All of these experts are expecting a future together in harness. Or is it the hangover that will be very different than the second from Rogoff’s supercycle of imprudent debt half of the 20th century, or even the so-far, accumulation that can only be remedied by not-so-good third millennium. But they are painful deleveraging while building an effec- influenced by different inclinations – toward tive macroprudential regulatory framework optimism or pessimism, toward cautious to prevent a repeat performance? Or, as Krug- repairs or an abrupt break with policy as man counsels, is the deeper problem our re- usual – to diagnose the malady and prescribe luctance to use the full panoply of monetary

the treatment. policy and fiscal tools that Keynes and his dis- jackson reuters/lucas The debate over secular stagnation is, I be- ciples developed? Or, à la Summers, are our lieve, the most important policy-relevant de- problems more fundamental, requiring a par- bate in economics since John Maynard adigm shift in the means and ends of eco- Keynes’s debate with himself in the 1930s, nomic policy? which transformed him from a monetarist to Successful management of the business the apostle of active fiscal policy. I think Sum- cycle, Summers argues, will also require gov- mers is largely right – but then, I would, since ernments to reduce wealth inequality, stimu-

late more productive societal investment and bottom: everett collection inc/alamy. © andrew lichtenstein/corbis. andrew lichtenstein/corbis.

bear more of the risk that now weighs heavily © J. Bradford DeLong is an economist at the University on households and businesses. Without gov- of California, Berkeley and creator of the blog “Grasping ernments willing to deal with the structural Reality.” He was deputy assistant secretary of the Treasury

in the Clinton administration. problems, he says, we are doomed to oscillate previous page: top: opposite page,

36 The Milken Institute Review tk

Fourth Quarter 2015 37 between asset bubbles in which much investment is wasted and growth is below sustain- aging the cycle in the future. able potential, and depression, in which un- Pre-World War I trust in the gold standard, employment is high and output is below combined with the conviction that business sustainable potential. confidence with “her magic wand” (in the Many other economists have contributed words of Alfred and Mary Marshall) must be to this debate – notably, Martin Feldstein, the highest priority of policy, was disastrous Richard Koo, Lars Svennson and Olivier in the changed environment of the interwar Blanchard. However, with Bernanke, Rogoff, years. The tool kits built in the 1930s during Krugman and Summers, we are already jug- the Great Depression focused on the impor- gling four balls, and that is more than enough. tance of decoupling national economies from an unstable world market, the utility of work- can economists learn fast sharing and the potential benefits of cartel- enough? ization in making businesses viable. They had It is a truth too often ignored that economic no application during the long post-World models and rules of thumb have the func- War II boom. And policymakers who viewed tional lifespan of fresh fish on a hot day. Ap- those golden years as confirmation of Keynes- proaches that help us to understand (and ian fine-tuning as the fix for all seasons left would have successfully managed) the busi- themselves deeply vulnerable in the face of ness cycle in the past are more likely than not the adverse supply, productivity and expecta- jim west/alamy jim

useless, or even worse than useless, for man- tive shocks of the 1970s. ©

38 The Milken Institute Review Everybody, it seems, is inclined to fight to- century and Eric Brynjolfsson of MIT pro day’s battle with yesterday’s stratagem. Think jects a future in which our principal eco- of the economists who came of age in the nomic problem is not scarcity, but finding 1970s. Ever since then, they have seen infla- useful and meaningful work to do. tion, currency debasement, low productivity growth and excessive government deficits the debate over secular lurking at every turn. They have had nothing stagnation constructive to offer since 1990. Economists worth listening to are not just And what of those who took the long, sta- saying the future is likely to be different from ble boom of 1984-2006 as an indication that the past; they are staking out turf as to how the macroeconomy had undergone a “Great it will be different. Of these, the most contro- Moderation” and could be managed with a versy has been generated by Summers’s secular- very light policy and regulatory touch? They stagnation thesis. were blindsided by 2007 and thereafter. Why Summers’s analysis is not, however, the have economists’ business-cycle theories al- right place to start. His interpretation is easier most invariably been wrong? Well, why to understand as the most recent in a string of should their theories be right? new approaches. The debate really started Inertia and hubris drive economics (and back in the late 1990s with Krugman’s book, so many other disciplines). Because they were The Return of Depression Economics. But that successful in answering past questions, econ- puts the cart before the horse. Let’s start with omists place heavy bets at unfavorable odds what “Depression economics” really replaced. on the proposition that the major shocks will What might be called “inflation economics” be of the same type and that changing insti- was born of the stagflation of the 1970s and

Why have economists’ business- tutions will not materially change the way cycle theories almost invariably economic shocks are propagated. Of been wrong? Well, why should course, the bettors almost always crap out. Finally, however, there are signs that their theories be right? economists (the smart ones, anyway) are learning that past shocks doesn’t tell us much early 1980s and focused on two goals. The about future ones. They are instead painting first was keeping expectations of inflation low. possible “if these trends continue” scenarios A central bank that sought to avoid inflation of major transformations. – and all central banks sought to avoid infla- Thus, Thomas Piketty of the Paris School tion – needed to either keep expectations of of Economics speculates about a scenario in inflation low or incur the heavy cost of engi- which wealth inequality brings about the end neering sufficient unemployment to lower of the social democratic era that began at the those expectations. Second, subject to that ex- start of the 20th century. Robert Gordon of pectations-management constraint, central Northwestern looks toward the likely end of banks sought to manage interest rates to keep the buoyant GDP growth brought on by the them in the sweet spot where inflation was second industrial revolution in the late 19th contained and the gap between actual and

Fourth Quarter 2015 39 secular stagnation subject to that, finding the aforementioned potential output was minimal. sweet spot for interest rates. Second, and in Why manage interest rates? Why couldn’t a particular: monkeying with spending and central bank simply set a neutral monetary taxes to try to balance the economy was ask- policy? Because nudging interest rates to the ing for trouble. Indeed, double trouble, if the level at which investment equals savings at government sought to accomplish its goals by full employment is what a properly neutral running large deficits that could produce an monetary policy really is. Over the decades, unsustainable debt burden. many have promised easier definitions of Third, once central banks became the cred- neutrality, along with a rule for thumb for ible guardians of low inflation and learned to maintaining it. All had their day: advocates of manage interest rates to sustain full employ- the gold standard, believers in a stable mone- ment, there was little reason for maintaining tary base, devotees of a constant growth rate the Depression-inspired straitjacket on finan- for the (narrowly defined) supply of money cial markets. Financial innovation ought to be and believers in a constant growth rate for welcomed – after all, it wasn’t the job of govern- broad money and credit aggregates. All of ment to play nanny to consenting capitalists. those theories were tried and found wanting. In broad terms, inflation economics de- The inflation-economics school of thought fined the worldview shared by three chairmen paid all due respect (and more) to free mar- of the Federal Reserve, Paul Volcker (1979-87), kets. First, adherents thought that govern- Alan Greenspan (1987-2006) and at least the ment distorted markets and caused collateral pre-2009 version of Ben Bernanke (2006-14). damage if policymakers pursued goals other Indeed, that was the consensus view of most

than maintaining inflation credibility and, economists and financiers of influence during time lifepicture records/the pictures/wpa life picture collection/getty images

40 The Milken Institute Review the 1985-2007 period of the Great Moderation. platitudes on being neither a borrower nor a Across that period, global financial markets lender. Bernanke saw a variety of drawbacks bobbed around like rubber ducks in a kiddie in an economy in which, on net, more than pool – remember the 1987 stock market crash, one dollar in 20 spent was borrowed abroad. the 1990 savings and loan crisis, the 1994 Mex- First, developing economies ought to have ican crisis, the 1997 East Asian crisis, the 1998 been investing their wealth at home, rather Long Term Capital Management collapse and than in the United States, in order to boost the 2001 dot-com collapse? Yet the faithful ex- their own productivity and wages. Second, by ecution of the rule of inflation economics gen- depressing interest rates and making Ameri- erated solid overall economic performance. cans feel richer, the incoming torrent of capital boosted both home construction and ben bernanke’s global household consumption and reduced domes- savings glut tic savings that might have financed invest- Although Krugman’s warnings of trouble ment in business productivity. Third, the cap- ahead came first, Bernanke’s diagnosis in the ital inflow pushed American workers out of mid-2000s precedes it in logical sequence. In export manufacturing, even as it increased a series of speeches back in 2005 about the U.S. international debts that could only be “global savings glut,” Bernanke, then a Fed serviced in the long run by exporting more governor (he had yet to be promoted), argued manufactured goods. that there was one blemish on the picture of The global savings glut, in Bernanke’s view, balanced growth of the U.S. economy: the was driven by multiple factors. For one thing, large trade- and current-account deficits. the aforementioned financial crises that rat-

reuters/mike segar reuters/mike This wasn’t a version of your boring uncle’s tled the developing world in the 1980s and

Fourth Quarter 2015 41 the global savings glut with the deregulated structure of Wall Street and the American housing bubble on the one hand, and the rigid 1990s had induced emerging-market coun- structure of the Eurozone and the wash of tries to borrow less abroad and to park their capital from Northern to Southern Europe on assets in stable climes. By the same token, fi- the other, led to a crash and the Great Reces- nancial instability had led the governments of sion that may prove to be more damaging than developing economies to conclude they the Great Depression. needed much larger liquid reserves. And the Yet today, as the North Atlantic economy is natural place to park those assets was the still groping its way forward seven years after United States, the country with the deepest, the crash, Bernanke continues to hold for the most liquid capital markets. most part to his global savings glut diagnosis As of the mid-2000s, Bernanke appeared of 2005. There is one difference. Back in 2005, confident that this shift in economic structure Bernanke saw the problem as driven by was on the whole unfortunate, but not over- emerging-market economies attempting to whelmingly damaging – and in any event, accumulate liquid assets. Today, he writes of would be temporary. In a matter of years rather falling current-account surpluses in these than decades, he suggested, emerging-market countries (the good news) offset by growing governments would acquire the liquid reserves surpluses in Eurozone countries that reflect they wanted. Then, international capital flows, Europe’s self-destructive determination to and with them asset prices and interest rates, stick to fiscal austerity. would return to their natural equilibrium. He’s acknowledged, moreover, that one Bernanke was, of course, wrong in 2005 in tenet of inflation economics – that the risk of a his belief that the forces driving hyper-low in- disorderly adjustment in financial global mar- everett everett collection historical/alamy

terest rates were transient. The interaction of kets really does necessitate effective macro ©

42 The Milken Institute Review prudential regulation of finance – was wrong. But other than that, he’s not changed his diagnosis. The global economy, he seems to be saying, suffers from a medium-run distortion dangerous vulnerabilities that predate those of in global capital flows and thus of elevated the 1970s and 1980s. He views the policies that asset prices and depressed interest rates. This created Bernanke’s savings glut as rational, distortion could be fixed quickly if surplus given the requisites of successful development. countries would adopt more sensible policies. Moreover, unlike Bernanke, he is very worried Moreover, even if it is not fixed, it can still be about the consequent fall in interest rates be- managed. cause it undermines the power of conventional Bernanke’s diagnosis thus falls into a stan- monetary policy. Accordingly, his prescription dard pattern for center-right economists. In varies from Bernanke’s appeal of collective rea- his view, if only market prices were not dis- son; what’s needed, he says, is a revival of old- torted, things would be good. But the govern- style Keynesian fiscal intervention. ment-caused distortions can be dealt with by One root of the problem, Krugman argues creating a global political-economic environ- convincingly, is that that central banks suc- ment that gives the Europeans incentives to ceeded too well in anchoring inflation expecta- play nice. tions. The folks who brought us inflation economics are thus in the position of the dog that krugman channels keynes caught the car. By inflicting a short but sharp Paul Krugman’s analysis differs from Bernan- depression on the North Atlantic economy ke’s in a number of ways. He sees the problems from 1979 to 1984, central banks convinced of the Great Moderation-era economy not as nearly all economic actors that they would easily correctable missteps but as major struc- offer zero tolerance for even moderate infla-

michael s. williamson/the washington post via via getty post images washington williamson/the michael s. tural problems that expose different and very tion. And they had subsequently reinforced

Fourth Quarter 2015 43 tk

44 The Milken Institute Review the hard line by pursuing policies that pushed hind the calls by, among others, the IMF’s inflation to 2 percent or less. chief economist, Olivier Blanchard, for an in- That success created a new vulnerability. flation target as high as 4 percent. With 2 percent inflation, the nominal interest If the policy announcement is credible, a rate consistent with full employment would two percentage point increase in the inflation be about two percentage points higher (4 per- target would have the same stimulus effect as cent). Now suppose some adverse economic a further two percentage point reduction in shock – the bursting of a housing bubble and interest rates. A second unorthodox route to a financial crisis, say – temporarily pushed that end: mammoth “quantitative easing,” in the interest rate consistent with full employ- the form of massive purchases of long-term ment down by six percentage points. Then government and government-guaranteed se- the central bank would find it impossible to curities with the goal of narrowing the gap lower interest rates enough to maintain full between long- and short-term interest rates. employment because the nominal rate With that in mind, back at the start of the couldn’t fall below zero. The economy would 1990s, Summers was willing to trust that tech- find itself in what Keynes dubbed a “liquidity nocratic central banks under loose political trap” – a situation dismissed in the postwar reins could guard against both the inflationary years as a theoretical curiosity – with no obvi- dysfunctions of the 1970s and the depression- ous levers a central bank could use to boost prone dysfunctions of the 1930s. demand back to full employment. Live and learn. The consensus has become Way back in 1992, in the wake of the mild that quantitative easing works, but only weakly. 1990-91 recession, Summers and I warned Reliance on monetary policy as an adequate against central bankers’ hubris with their suc- tool for macroeconomic management thus cess at inflation-expectations management: Larry Summers was willing to trust that technocratic central banks under loose political reins could guard against

Can [monetary] austerity be both the inflationary dysfunctions overdone? … The relaxation of monetary policy seen over the of the 1970s and the depression-prone past three years in the United dysfunctions of the 1930s. States would have been arith- ria novosti/alamy © metically impossible had inflation and nominal interest rates both been three percentage required that the central bankers could talk points lower in 1989. Thus a more vigorous the public into raising its expectation of infla- policy of reducing inflation to zero in the tion. And because he feared that they couldn’t, mid-1980s might have led to a recent recession Krugman believed that Depression economics, much more severe than we have, in fact, seen. complete with the liquidity trap, had returned. It is difficult to read the macroeconomic Krugman is not as alone in his fears. For history of the past decade as anything other while the economics profession may still be everett collection inc/alamy. bottom: bottom: everett collection inc/alamy.

top: top: Cassandra. A similar reading of events lies be- for guiding us back to full employment, it is

Fourth Quarter 2015 45 secular stagnation no growth and no inflation. The problems difficult to find many economists who are op- Krugman described were transitory, Rogoff timistic about the ability of a central bank to thought, at least in the medium-run sense. boost a deeply depressed economy operating They could have been avoided when they oc- at the zero lower bound on interest rates by curred and could be avoided in the future by changing inflation expectations. appropriate macroprudential regulation to Central bankers are chosen from among avoid the buildup of excessive debt. Once the those who are deeply averse to abandoning crisis hit, Rogoff argued, policies to rapidly what they see as the expensive success (in deleverage economies could reduce the terms of the excess unemployment) of reduc- trauma but not eliminate it. In large measure, ing expected inflation to 2 percent. Raising the situation simply needed to be toughed out. that anchor, they fear, would return us to the Rogoff has consistently viewed what Krug- bad old days of the 1970s, when relatively man sees as a long-term vulnerability to De- small missteps might trigger an inflationary pression economics as the temporary conse- spiral that required a deep and prolonged re- quences of failures to properly regulate debt cession to untangle. accumulation. Eventually, a large chunk of Market observers know that central bank- debt thought of as relatively safe is revealed to ers love their inflation anchors. Thus, as Krug- be risky, and financial markets choke on the man put it, bankers “promising to be irrespon- lump. As the riskiness of the debt structure is sible“ are unlikely to be believed. From revealed, interest rate spreads go up – which Krugman’s perspective, then, Bernanke’s means that interest rates on assets already global-savings-glut assessment is much too known to be risky go up, and interest rates on optimistic. Krugman has recommended ag- assets still believed to be safe go down. gressive use of expansionary fiscal policy to get It is the debt-accumulation cycles, Rogoff economies out of the liquidity trap once they argues, that cause the stagnation problem. fall in. He also favors vigorous use of exchange- They inevitably end in a morass of distressed rate and nonstandard monetary policies in loans, which is what creates the economy’s these circumstances, though with less confi- vulnerability to the zero-bound problem. The dence than he has in fiscal policy. And he has consequences look like those of Krugman’s called for higher inflation targets to create Depression economics, but the cause is sim- more maneuvering room to prevent a fall ply too much risky debt. Deleveraging can be into a liquidity trap in the first place. helped along by government-enforced debt But when he wrote the book, in 1998, he write-downs and other heterodox policies. had little confidence in the ability of these But it cannot be avoided. policy shifts to eliminate the dangers of De- Rogoff argues that this “debt supercycle pression economics. And with hindsight, it model matches up with a couple of hundred appears that he was 100 percent right. years of experience.” There is, in his view, nothing new or unusual in the post-2008 re- rogoff’s supercycle of debt action to the financial crisis. Debt accumula- Rogoff’s diagnosis, the third in the logical se- tion, the consequent enormous rise in risk quence (after Bernanke’s and Krugman’s), spreads and a long depressed slog while the was originally conceived as a critique of Krug- overhang poisons investment and aggregate man’s interpretation of Japan’s lost decades of demand are simply par for the course.

46 The Milken Institute Review Rogoff’s assessment comes with an im- rately. “In a world where regulation has plicit prediction that interest rates will now sharply curtailed access for many smaller and rapidly normalize. In his view, the Fed is, if riskier borrowers, low sovereign bond yields anything, behind the curve in postponing its do not necessarily capture the broader ‘credit first hike in the interest rates until the end of surface’ the global economy faces,” he says. 2015. By this reckoning, the Fed’s big problem I have a difficult time untangling Rogoff’s in two years is more likely to be incipient in- analysis. Surely if good public investments flation than rising unemployment. are even better deals in a crisis, mediocre If Bernanke’s policy recommendations are public investments cross the line to accept- a combination of macroprudential financial able deals. Surely there is little to fear when regulation and exhortation of governments interest rates are low and the central bank has to play by the rules, and Krugman’s policy recommendations are a return to Keynesian arket observers know reliance on expansionary fiscal policy at the M zero lower bound for interest rates, Rogoff’s that central bankers love recommendations for policy are more com- plex – and a bit muddled. their inflation anchors. Rogoff calls for a higher inflation target, Thus, as Krugman put it, along with a willingness to break the pattern when circumstances change, for he believes bankers “promising to that “central banks were too rigid with their be irresponsible” are inflation target regimes” when the crisis hit. And he calls for aggressive debt write-downs unlikely to be believed. – both private and public – along with aggressive macroprudential policies to prevent a re- the power to print money to pay off the debt, peat performance. if necessary, to avoid a rollover crisis. But Rogoff seems confused (or at least in- And you may point out: extraordinary for- consistent) on the role of fiscal policy when eign demand today for dollar-denominated the economy is in a liquidity trap. He sounds securities as safe, liquid stores of value are not like Krugman when he says that fiscal policy just the consequence of a supercycle of exces- “was initially very helpful in avoiding the sive debt issue. They reflect the insane auster- worst of the crisis, but then many countries ity and secular stagnation in Europe. They tightened prematurely.” And he still sounds also reflect the global imbalances caused by like Krugman when he acknowledges that, China’s rapid export-led growth and poten- “With low real interest rates, and large num- tial political instability. bers of unemployed (or underemployed) If you were to say all that, you would not construction workers, good infrastructure be Ken Rogoff, but Paul Krugman. And you projects should offer a much higher rate of would be well on the road toward agreeing return than usual.” with Summers. But he hedges, wondering whether the bal- looning risk spreads that make safe debt such summers’s leap a bargain and infrastructure investment so “Secular stagnation” was a bad phrase for tempting reflect economic conditions accu- Summers to have chosen to label the position

Fourth Quarter 2015 47 secular stagnation 2. Limits on the demand for investment he has staked out. He wanted to evoke associ- goods coupled with rapid declines in the ation with Keynes’s disciple, Alvin Hansen, prices of those goods, which together put too who in the wake of World War II worried that much downward pressure on the potential declining population and productivity profitability of the investment-goods sector. growth would reduce the rate of profit and 3. Technological inappropriateness, in the incentive to invest, and so create an econ- which markets cannot figure out how to omy that was trapped in Krugman-style properly reward those who invest in new Depression economics by a permanent insuf- technologies even when the technologies ficiency of investment to sustain full employ- have enormous social returns – which in turn ment demand. But the mechanisms that lowers the private rate of return on invest- Summers points to are different from those ment and pushes desired investment spend- of Hansen. He should, at the least, have called ing down too far. it “Secular Stagnation II.” 4. High income inequality, which boosts Summers’s core worry is not about the im- savings too much because the rich can’t think mediate aftermath of a crisis. Nor is it just of other things they’d rather do with their about the medium run of the unwinding of a money. debt supercycle or of Bernanke’s government- 5. Very low inflation, which means that reserve accumulation that produces a glut in even a zero safe nominal rate of interest is too savings. It is that the global economy – or, at high to balance desired investment and least, the North Atlantic chunk of it – will be planned savings at full employment. stuck for a generation or more in a situation in 6. A broken financial sector that fails to which, if investors have realistically low expec- mobilize the risk-bearing capacity of society tations, central banks reduce interest rates to and thus drives too large a wedge between the accommodate those expectations and govern- returns on risky investments and the returns ments follow sensible fiscal policies, the pri- on safe government debt. vate financial markets will lack sufficient ap- Hansen focused on cause-one; Rogoff fo- petite for risk to support a level of investment cuses on cause-six, in the form of his debt su- demand compatible with full employment. percycle; and Krugman focuses on five and Thus economic policymakers will find six. Summers has, at different moments, themselves either hoping that investors form pointed to each of the six causes. unrealistic expectations – prelude to a bub- It is to Summers that we have to look to ble – or coping with chronic ultralow interest see why this confluence of Depression eco- rates and the associated risks of stubbornly el- nomics symptoms has emerged now – and evated unemployment. Such “badly behaved why it is turning out to be such a deep and investment demand and savings supply func- stubborn problem. For it is not just one or tions,” as Martin Feldstein called them when many of Feldstein’s causes – or for that matter, he taught this stuff to me at Harvard back in Bernanke’s badly behaving governments that 1980, could have six underlying causes: don’t qualify for the list – that lie at the root 1. Technological and demographic stagna- of the problem. It is that historical trends tion that lowers the return on investment and right now are driving all of these potential pushes desired investment spending down causes together, and are driving them in the too far. same direction.

48 The Milken Institute Review that relies on interest rates significantly below Thus Summers seeks to dive deeper. The growth rates for long periods virtually en- policy changes he has in mind are different sures the emergence of substantial financial from standard supply-side measures or de- bubbles and dangerous buildups in leverage.” mand-side reliance on temporary expansion- Moreover, he asserts that the idea macropru-

vespasian/alamy ary fiscal policy or raising the inflation target. dential regulation would “allow the growth © Summers dismisses the largely Republican benefits of easy credit to come without cost is focus on “deep supply-side fundamentals: the a chimera.” skills of the workforce, companies’ capacity Instead, he wants the government to step up for innovation, structural tax reform and en- to the plate across a very broad range of initia- suring the sustainability of entitlement pro- tives. Why does it have to be the government? grams,” which he calls “unlikely to do much” Is it really the case that there aren’t enough in any reasonable time frame. He also dis- good private investment opportunities in misses the fix of higher inflation targets that America? Or would it be better to say that there would allow central banks to push real inter- aren’t enough good relatively safe private in- heritage image partnership ltd/alamy. right: right: ltd/alamy. image partnership heritage

left: left: tional monetary policy: “A growth strategy it be better to say that there is now a large-scale

Fourth Quarter 2015 49 secular stagnation the-costs rationale, but because full employ- systematic failure to mobilize the economy’s ment depends on it. Thus, for example, Sum- risk-bearing capacity? Yes, yes and yes. mers calls for very active environmental The government should thus be taking ad- regulation. Full employment requires finding vantage of the global savings glut to borrow something expensive to invest in, and fight- and spend, Summers argues. ing global warming is the most useful thing The [approach] that holds the most promise is that is likely to be expensive enough to make a commitment to raising the level of demand a difference. at any given level of interest rates through Some say that investments to fight global policies that restore a situation where reason- warming should be made slowly, postponed able growth and reasonable interest rates can coincide … ending the disastrous trends until better science gives us a better handle on toward ever-less government spending and the problem. Summers finesses this argument, employment each year and taking advantage pointing out that the cost of the resources in- of the current period of economic slack to vested would be very low as long as the econ- renew and build out our infrastructure. omy is stuck below full-employment equilib- What’s more, he says, “If the federal gov- rium. Thus he sees a need for carbon taxes to ernment had invested more over the past five accelerate the phaseout of coal power, which years, the U.S. debt burden relative to income need to be much more than offset by spend- would be lower; allowing slackening in the ing to accelerate the buildup of renewable en- economy has hurt its long-run potential.” ergy sources and other carbon-sparing energy In this view (which I share), more of the technologies. risk-bearing and long-term investment-plan- In Summers’s view, the experience of the ning and investing role needs to be taken over last two decades – the oscillation between a by governments. We strongly believe that dangerously depressed economy and a dan- governments with exorbitant privilege that gerously bloated bubble economy, with seem- issue the world’s reserve currencies – notably, ingly no ability to find or maintain the sweet the United States – can take on this role with- spot – is not inevitable. But the problems out any substantial chance of loading future are deeper than the market and political dys- taxpayers with inordinate debt burdens. But functions diagnosed by Rogoff and Bernanke, the government should be doing more to pre- and not as easily cured by pure demand- vent stagnation. management policies as one might conclude • It needs to take aggressive action to re- from Krugman. duce income and wealth inequality in order That does leave a loose end. Why would a to get money into the hands of those who will higher inflation target – one that would allow spend it rather than save it. monetary policy to pack a bigger punch – not • It needs to invest more in research to sup- be sufficient? Summers’s explanation is a tad plement the pace of privately driven techno- esoteric. logical progress. In his view, there are worthy private risky • It needs to curtail the power of NIMBY investment projects and unworthy ones. Wor- (not-in-my-backyard) interests that make thy risky projects have a relatively low elastic- some productive investments unprofitable. ity with respect to the required real yield – The reason for government investment is that is, lowering interest rates to rock-bottom not your garden-variety, the-benefits-exceed- levels would not induce much more spending.

50 The Milken Institute Review In contrast, unworthy risky investment proj- nihilism is not a policy ects have a high elasticity. Thus, when safe in- A better case against Summers’s policy recom- terest rates get too low, savers who should not mendations is rooted in general skepticism be bearing risk nonetheless reach for yield – about his reliance on increased government they stop checking whether investment proj- intervention. The argument isn’t that more ects are worthy or unworthy. spending by a competent government would Put it another way: there are people who not work, but rather that the government isn’t should be holding risky assets and there are sufficiently competent or is too encumbered people who should be holding safe assets. The by interest groups to make it work. By this problem with boosting inflation so that the reckoning, additional government investment central bank can make the real return on is worse than useless in a contemporary free- holding safe assets negative is that it induces market democracy for the same reasons that

F ull employment requires finding something expensive to invest in, and fighting global warming is the most useful thing that is likely to be expensive enough to make a difference.

people who really should not be holding risky government investment in, say, hopelessly in- assets to buy them. efficient steel mills or railroads to nowhere I would speculate that, deep down, Sum- was worse than useless in the crony-Socialist mers still believes in one tenet of inflation environment of the Soviet Union. economics: that effective price stability – the The view that any expansion of the gov- expectation of stable 2 percent inflation – is a ernment’s role in the economy is bound to very valuable asset in a market economy. And make us worse off certainly has its supporters with the right sorts of government interven- among public-choice economists as well as tion discussed above, there is no need to sac- among red-meat Republican conservatives. rifice it. A mix of income redistribution, mo- But I agree with Summers that the public- bilization of the economy’s entrepreneurial choice economists have taken solid explana- risk-bearing capacity and an infrastructure- tions for government failure and driven them oriented fiscal policy could do the job. “relentlessly towards nihilism in a way that Is there a strong argument against Sum- isn’t actually helpful for those charged with mers’s reading of the situation or his recom- designing regulatory institutions,” or, indeed, mended policies? The alternatives offered “making public policy in general.” above, a nudge in the global adjustment pro- Nihilism grounded in theoretical first prin- cess à la Bernanke or Rogoff (in the hope that ciples is simply not a useful guide to policy. “secular stagnation” isn’t secular after all) or a We will not know the limits of government ac- Krugman-style fix that relies on more aggres- tion to remove the structural impediments sive monetary and fiscal intervention don’t that have produced our vulnerability to convince me. secular stagnation until we try them.

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