Summers’ Deeply Pessimistic On U.S. Economic Growth Prospects

And he doesn’t even mention Obamacare, which I think could significantly — in a very negative way — impact consumer spending — which is 70% or our GDP


Larry Summers Has a Wintry Outlook on the Economy

By Peter Coy and Matthew Philips

November 18, 2013

Larry Summers, the man who was almost chairman of the Federal Reserve,
is awfully gloomy about U.S. growth prospects.

In a Nov. 8 speech at the International Monetary Fund, he suggested
the U.S. might be stuck in “secular stagnation”—a slump that is not a
product of the business cycle but a more-or-less permanent condition.

Summers’s conclusion is deeply pessimistic. If he’s right, the economy
is incapable of producing full employment without financial bubbles or
massive stimulus, both of which tend to end badly.

The collapse of the debt-fueled housing bubble led to the crisis of
2007-09, and some policymakers worry that the Fed’s easy-money
approach is setting the economy up for another fall. Witness the Dow
Jones industrial average surpassing the 16,000 mark on Nov. 18.

The problem, as Summers sees it, is that the economy is being held
back by what economists call the “zero lower bound”—interest rates,
once cut to zero, can’t be reduced further to stimulate the economy.

In a typical slump, the Federal Reserve encourages borrowing by
reducing the interest rate to substantially below the rate of
inflation, so people are effectively being paid to take out loans. (In
econ jargon, that’s a “negative real interest rate.”)

But interest rates can’t be much below inflation when the inflation
rate itself is close to zero, as it is now.

Summers speculates that the interest rate would need to be 2 or 3
percentage points lower than the inflation rate to get the economy

Right now that’s impossible: The Fed’s favored short-term measure of
inflation is just 1.2 percent, and the federal funds rate can’t go any
lower than its current range of zero to 0.25 percent.

That, says Summers, is why the economy is stuck in a rut. “We may need
to deal with a world where the zero lower bound is a chronic and
systemic inhibitor.” He didn’t offer a solution in his speech, and
could not be reached for an interview.

Summers, favored by many in the White House to run the Federal
Reserve, withdrew from consideration in September, and now Fed Vice
Chairman Janet Yellen is the nominee. While critics argued that
Summers lacked the proper temperament to lead the Fed, no one has
questioned his credentials as an economist.

At age 28, he became one of the youngest tenured professors in Harvard
University’s history on the strength of his economic research. He’s
also been Treasury secretary to President Bill Clinton, president of
Harvard, and director of President Obama’s National Economic Council.

Plenty of economists aren’t persuaded by Summers’s diagnosis of what
ails the U.S. economy. “Instead of having more experiments with free
money, let’s try the experiment of actually passing a budget.

Wouldn’t that be novel?” says David Rosenberg, chief economist at
Canadian investment firm Gluskin Sheff. “I fail to see how negative
real interest rates are the correct prescription,” he says. “How would
you ever encourage the private sector to lend money at negative
interest rates?”

Adds Douglas Holtz-Eakin, a former director of the Congressional
Budget Office who served as John McCain’s chief economic adviser
during the 2008 presidential campaign: “We’ve had four years of
extraordinarily loose monetary policy without satisfactory results,
and the only thing they come up with is that we need more?”

Joseph LaVorgna, chief U.S. economist for Deutsche Bank (DB), says the
economy doesn’t need extreme measures, because it’s starting to
recover on its own.

Pushing rates sharply negative—presumably by raising the rate of
expected inflation—could rattle investors, LaVorgna says. “It could
affect confidence and be a challenge to the animal spirits.”

Even some liberals sympathetic to Summers’s arguments aren’t fully on
board. “How sure are we that negative real rates would give us the pop
we need?” asks Jared Bernstein, a senior fellow at the Center on
Budget and Policy Priorities. “It’s not obvious.”

Summers has heard these arguments before. His point is that the
conventional wisdom has failed—the medicine that once worked isn’t
working anymore.

If the economy’s “natural” interest rate is now substantially below
zero, he said in the speech, “conventional macroeconomic thinking
leaves us in a very serious problem.”

What are the options if Summers is right?

One is to continue monetary and fiscal stimulus. But that inflates the
national debt and, possibly, asset bubbles. University of Michigan

Miles Kimball has another approach: Break the zero lower bound by
placing sharply negative interest rates on deposits—i.e., charging
customers for keeping money in the bank.

Depositors would normally defeat this tactic by pulling their money
out and keeping it in cash. So Kimball proposes devaluing cash itself
by tying its value to that of money deposited in the bank.

“Paper currency could still continue to exist,” Kimball writes, “but
prices would be set in terms of electronic dollars (or abroad,
electronic euros or yen), with paper dollars potentially being
exchanged at a discount compared to electronic dollars.”

In practical terms, shoppers who paid cash would be assessed a
surcharge that would grow over time. The pressure on consumers to buy
before their money lost value would be intense.

Money that automatically loses value might seem like an overly risky
tactic—unless Summers is right that the U.S. is sinking into a
Japanese-style deflationary rut. In that case, bring on those negative

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