Secular Stagnation and the Future of Global Macroeconomic Policy


April 15, 2019, 12:15 PM to 1:30 PM EDT
PIIE Webcast, Washington, DC

Lawrence H. Summers (Harvard University)

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Event Summary

Lawrence H. Summers discussed “Secular Stagnation and the Future of Global Macroeconomic Policy" at the Peterson Institute for International Economics on April 15, 2019. Summers, the Charles W. Eliot University Professor and president emeritus at Harvard University, argues that events of the last five years confirm that secular stagnation is real and spreading, and that fiscal not monetary policy will play the major role in stabilization policy going forward. As a result, Summers contends that the industrialized world has passed peak central bank independence, and that secular stagnation is ironically a product of the information technology revolution—supply side progress has created demand side problems.

Summers was the 71st secretary of the Treasury under the Clinton administration.  He also served as director of the White House National Economic Council in the Obama administration, as president of Harvard University, and as chief economist at the World Bank. Summers is vice chair of PIIE’s Board of Directors and a member of its Executive Committee. 



Lawrence Summers: Thank you very much. Adam you were doing splendidly in that introduction when you were explaining how I had been completely right about secular stagnation and entirely vindicated and I was thinking we should just turn over the whole program to you and I could just smile proudly and then you failed me entirely in the first law of politics which is to manage expectations by talking about all the bold new ground that I was going to break today and so now I feel somewhat daunted and intimidated about being in this August company but I guess I will find the courage to carry on despite what you have done to me.

My topic today is secular stagnation, how I've come to think about it and how I think policymakers going forward are gonna have to think about it in the future. I put it forward at the IMF five or six years ago in a quite tentative way, broadly the data flow since then have led me to be much more confident about it. Interest rates have been much lower than would have been imaginable then. Fiscal deficits have been much larger than seemed plausible then. So the accelerator has been much closer to the floor. And yet the vehicle of the industrialized economy has moved forward much more slowly than was anticipated then. And the rate of inflation has remained much lower than was anticipated then.

So, when you have much more fuel and a much heavier foot on the accelerator than you expect, and the car goes slower than you expect; you should think that something is different about the car than you had figured.

First, real rate. I'm going to talk almost entirely about the industrialized world as a unit. That turns out to be a good thing to do because rather remarkably, the aggregate current account deficit of the industrial world has been very close to zero for the last 25 years and has trended upwards only slightly.

So, the -- while there have been big changes in individual country flows, the industrial world can be relatively well approximated as a closed economy and a closed -- as a single closed economy. That closed economy today has negative real interest rates. Markets predict that those negative real interest rates will remain negative for the next 30 years even without adjustments for term premia and markets predict that the two percent inflation target will not be attained anytime in the next decade.

Real interest rates are some 350 basis points lower than they were 20 years ago. One can look at real interest rates on Treasuries. One can look at real interest rates on triple-A bonds on BAA bonds. One can look at estimates of the equity risk premium. A single principal component explains 95% of all of the variation in those and that is a downwards trending principal component. I say that to emphasize that for the purpose of talking about this big trend towards lower real interest rates, the action is not in the relative returns of one kind of asset versus another kind of asset but is in some overall asset return.

The issues raised by the so-called safe asset shortage literature are second order. This 350 to 400 basis point decline has taken place despite a substantial move towards fiscal expansion over the longer term. Nobody really knows what the slope of the I.S. curve is or equivalently what the impact of fiscal deficits on real interest rates are.

There is a presumption that when people try to estimate it, they probably estimate it too low. One because they estimate it for individual countries. And so you don't see the effect that you would see from a fiscal expansion for the whole world and two, because there's the tendency for deficits to be larger when aggregate demand is softer which causes larger deficits to be correlated with lower interest rates.

Since she's in the audience, I'll quote Stan Fisher's estimate after reviewing the Fed model and a variety of the literature; he suggested that a 1 percentage point increase to the deficit to GDP ratio would raise interest rates by about 50 basis points. If one uses that figure, the roughly 3 percent increase in deficit to GDP ratios that has taken place should have raised real interest rates by 150 basis points. In fact, they have declined by 350 basis points.

The increase in budget deficits is not the only thing that should have operated in that direction. Considerable deregulation, lower taxes on capital income and critically, increases in pay as you go Social Security programs should all have operated to reduce saving and therefore raise real interest rates. Our estimate with Lucas Rachel, which has a very high standard error associated with it was that those effects, the deficit effects, plus the other effects I mentioned are 400 basis points. So if you ask, what is the pure effect that has taken place because of changed private savings and private investment behavior; it is on the order of 700 basis points over the last 30 years. Much of which has been offset by changes in economic policy.

Or to put it differently, the structural gap between private saving and private investment, which has of course come way down because interest rates were lower, would if interest rates had not declined, be approximately 10 percentage points today. So something quite large and fundamental has happened.

Second broad point I want to make. This kind of issue of secular stagnation or equivalently under consumption and associated issues of low interest rates, shortfalls in aggregate demand and deflationary pressure is not a new thing under the sun. Great Britain ran a 10% of GDP, a current account surplus for 30 years during the imperial period because of an excess, a chronic excess of saving over investment, despite very low interest rates and only managed to achieve adequate aggregate demand by being a major net exporter to the rest of the world.

Alvin Hansen pointed out this tendency in the industrial economies particularly the United States during the 1930s. The story is often told that he was wrong. I actually think he was right, but World War 2 started. It is very clear if you read any history of the period, that but for the arrival of World War 2 and the associated rearmament; Roosevelt would have left office a failure in 1940 with the New Deal regarded as unsuccessful and unemployment remaining in double digits.

It was the nearly universal projection of American economists during the Second World War, that the economy would revert to stagnation after the Second World War. an event that proved wrong in part, because of the pressures of cold war spending, in part because they didn't take account of the large wealth that people felt the need to spend that was accumulated while there was rationing during the Second World War and in part because of major initiatives like the FHA that were directed at substantially stimulating spending after the Second World War.

It is interesting to go back and read the economic literature of the 1950s, even the first economic report of the new Kennedy administration, which felt that the economy faced a challenge of chronic underemployment that would be met only with a substantial structural permanent increase in the government budget deficit, something that took place with the 1964 tax cuts. Indeed if one thinks about the last two years before the financial crisis, one is struck that the United States had the mother of all housing bubbles, vast erosion of credit standards, an effort to simultaneously fight the Iraq war and provide major tax cuts, very easy monetary policies and growth in the two percent, two and a half percent range. Adequate but hardly overheating or extraordinary.

So this phenomenon of weak chronic demand is not the ubiquitous state of modern economies, but it is not some kind of novelty either. It was present and was substantially adapted to in Britain, in the United States in the 1930s, in the United States in the 1950s, in the United States in the early part of the last decade. And of course more recently in Japan. And so it should not be thought of as something bizarre or entirely out of the ordinary.
Third large observation. It is a serious mistake to treat this as a mere technicality around the extended lower bound on or zero lower bound on nominal interest rates because the tendency is to say yeah, yeah, yeah. But isn't this all just a lot of hoo ha for basically saying that the interest rate can't fall below zero. It might need to fall below zero. And so that's a problem. But you don't have to talk about it like it's some very different theory of how the world operates.

I don't think that's the right view. First, I think the zero interest rate or some interest rate close to zero as a lower bound is a practical constraint in modern economies. And we are unlikely to become so cashless that that constraint does not remain as an issue. And there would likely be serious political ramifications to a move to significantly negative interest rates.

Second it is far from clear that reductions in interest rates, significantly through zero would be positive in their impact on aggregate demand. Considerable doubt surrounds their implications for the health of financial intermediaries. Measures which constrain the profitability of financial intermediaries and bear on their capital positions may have substantial implications for the flow of credit. Target savers are adversely impacted by lower interest rates and may be led to increase rather than to decrease their saving and so reduce their consumption as interest rates fall.

Essentially equivalent, there is a non-trivial income effect from lower interest rates as future consumption becomes more expensive and people who are planning to devote a significant fraction of their wealth or income to future consumption, experience themselves as poorer. So, the impact of lower interest rates is unclear on demand. And while this has been not studied to the point where one can be at all definitive, there are reasons for fearing the economic consequences of very low or negative interest rates, even if they were feasible and even if they were efficacious in stimulating aggregate demand.

These include a greater propensity to asset bubbles, the perpetuation of zombie enterprises as loan payments don't come due, something that was seen as a real problem in Japan during the first decade of this century. Incentives to substantially increase leverage with associated risks for financial instability and recent suggestions that it may lead to a deterioration in competitive dynamics and pressure to increase productivity growth.

So, I think it is wrong to suggest that somehow if you just can be imaginative about the zero lower bound; you can make these issues which we now seem likely to face, go away. What then are the appropriate policy responses and how should policy makers think about the challenge that I've described.

I would distinguish initially, two separate issues. The first is contingency planning for recession and the second, is the ongoing posture of policy.

With respect to contingency planning for recession it needs to be recognized that recessions come as events with probability on a conservative basis 15 to 20 percent a year. So, the odds that we will have one in the next five years are very high, in the industrial world. And that the world has had one fundamental strategy for dealing with recession which is unlikely to be operative in the future.

That being a five hundred basis point reduction in base interest rates. The lion's share of the response to the next recession will have to come from fiscal policy. And now is the time to begin thinking about inventories of undone infrastructure projects, opportunities for maintenance and accelerated procurement, devices for cutting taxes in ways that would provide for a maximum propensity to spend; giving the tax refunds in the form of debit cards for example or other devices.

But we do not currently have the political consensus in place that would permit rapid and substantial movement towards expanded deficits in the event of recession, nor any backlog of identified attractive projects to put rapidly in place on spending. When I say we do not have, I speak with considerable confidence about the United States and with strong suspicion that something similar is true in Europe and in Japan.

The more fundamental question is can we identify a package of policies that will operate to raise the level of demand and so permit the maintenance of full employment at higher levels of interest than are now, than the negative real rates that are now necessary for full employment.

Let me start with fiscal policy. As I have been suggesting for some time and as Olivier explained with extraordinary elegance and clarity in his AEA presidential address, a low rate of interest and in particular a rate of interest significantly below an economy's growth rate changes; fundamentally the calculus with respect to fiscal policy. It enables primary deficits to be run without debt to GDP ratios expanding indefinitely. It more broadly permits larger deficits with less concern about sustainability, and it reduces the hurdle rate of return that should be applied to public investments.

Any one of us would agree that the appropriate house to buy for someone with an income of two hundred thousand dollars is substantially more expensive when the interest rate is 2 percent than when the interest rate is 8 percent. By the same logic, whatever the right debt to GDP ratio is or was traditionally at the time when the Maastricht criteria were formulated; something different is appropriate today and more generous. But the scope for fiscal policy actions that increase demand, is not limited to measures which change the measured budget deficit.

There are at least two other broad categories of measures that one would expect would be substantially availing in increasing demand. The first is measures which redistribute income from those with a higher propensity to save to those with a lower propensity to save. The economic evidence is increasingly clear that those with a higher income typically have a higher propensity to save than those with a lower income. And so measures which increase the progressivity of tax and benefit schedules operate to stimulate aggregate demand. There is also a case for measures which redistribute from young to old. As Marty Feldstein pointed out several decades ago, the Social Security program has a substantial impact by providing income security for people during their retirement to enable them to save less during their pre-retirement years.

Cain's actually pointed out when he came to Washington in 1942, that this was an important virtue of Social Security, because it would make secular stagnation less likely after the war. Pay as you go Social Security, that is Social Security that collects from the young each year and spends on behalf of the aged each year in equal measure does not change the measured budget deficit but does operate to raise aggregate demand and consumption.

So the first large area that needs to be thought about differently, is fiscal policy. I would argue that even without secular stagnation there is a substantial case for strengthening Social Security and moving towards a more progressive tax system. But that case is magnified in the presence of secular stagnation.

Second. There is the global arena. It is actually rather shocking, if one steps back from it all, to think that the world can be broadly divided into an aging, slowly growing, north and a young, more rapidly growing, south and that there is no net flow of capital from north to south. Indeed, while I think the argument is overdone and if it had applicability a decade ago, almost certainly does not have applicability today; the suggestion is sometimes made that a flow of capital from the south to the north through some kind of savings glut has reduced interest rates.

Stronger more effective international financial intermediation that encouraged the flow of capital from north to south would raise returns for investors in the north, provide opportunities for convergence for those living in the developing world and help to address the challenge of secular stagnation. From this perspective the ongoing skepticism about the IMF, the ongoing skepticism about providing adequate funding for the global development institutions, is quite unfortunate.

And it needs to be said that from this perspective, the efforts being made by China to support increased investment throughout the developing world are a constructive force. Of course provision of increased trade finance and the reduction of protectionism would also be constructive forces in increasing the flow of capital from north to south.

Third, this line of thought that a shortage of demand and a lack of investment has important implications for regulatory policy. It reinforces the case that where one has burdensome regulations that discourage business investment and do not serve an important social function it is desirable that they be removed. But I'm not sure how many cases of that kind there are. But there are other forms of regulation which may or may not be welcomed by business but are surely pro investment.

For example, consider a requirement that coal fired power be phased out within the next decade. That is a regulation that unambiguously will encourage new capital investment. Consider regulations that require the installation of new renewable technologies. That too, is a step that will operate to increase investment demand.

I'm not sure what a green new deal means, but if a green new deal means an acceleration of rational measures that involve significant investment in service of reducing global climate change; it will have the virtue of helping to reduce secular stagnation as well as whatever other virtues that it possesses.

Similar arguments can be made for other kinds of regulatory mandates, whether those mandates be the increased flow of capital to those with low incomes who wish to borrow to buy homes, or the installation of more elaborate devices to assure worker safety in factories. There are a set of regulatory mandates that may or may not be profitable for individual businesses but very clearly will raise the level of total investment and absorb saving.

I'm going to stop here with the observation, as I conclude, that real interest rates are far higher in the United States than they are in Europe and Japan, that growth is more rapid, and that the inflation target of 2 percent is more closely being achieved in the United States than in the remainder of the industrial world.

And so the case for the approach that I've described, emphasizing raising the level of demand, while strong in the United States, is I believe even stronger in the rest of the world. Further I would suggest that almost everywhere, inflation targets are framed in terms of an average inflation rate of 2 percent. If the eleventh year of economic recovery, when the unemployment rate is below 4 percent and when inflation has been below the 2 percent target for 10 years; if that is not the time when inflation should be above 2 percent, I cannot imagine when that time would be.

So, if the policies that I have suggested were to prove somewhat inflationary and lift inflation rates in the industrial world, I would suggest that that is a feature rather than a bug and would have the final virtue of allowing more room for cutting interest rates when the next recession comes. Thank you very much.

Adam Posen: Thank you, Larry. I hope you accept my setting high expectations was largely fulfilled. But also that since you do it to me from our board, it was only fair play. Joking aside, this is obviously moving on to the next step in dealing with the world we face today. And I'm grateful to Larry for taking this brave move, to take it where his analysis goes and to bring it to us here for discussion. Let me ask you a couple of questions to expand on some things in your talk and then we'll open it up to the audience as a whole.

First off, just on your last point or second to the last point, linking the idea of Pro-Green regulation and change as potentially a deficit neutral way to do fiscal policy. That would seem, in some ways though, to run counter to your desire to increase capital flows from north to south, because that would mean a scrapping and building of capital in the US. That doesn't mean it's a wrong recommendation. But as you think through this idea of capital flows, and particularly vis-à-vis China, is there a way of getting other countries around the world involved in this green push?

Lawrence Summers: Look, I think everywhere, from the point of view of the arguments I've made, any place you increase investment, you're changing the supply and demand for funds in favor of raising the demand and therefore you're acting to raise interest rates. And so the case would be stronger for a global movement to implement renewable technology.

I think it will be good if it was done in the United States. Better if it was done in the United States and Europe. Better if it was done and still if it was done in the United States Europe and Japan. And best of all, if it were done everywhere. I think we don't understand quite as well as I'd like us to, how to think about the ultimate determinants of the Chinese current account surplus or Chinese current account behavior. So, if China were led to increase its environmental investment, a naive view, might be the right view would be that that would increase investment and S minus I would cause them to be in a stronger current account deficit position.

If their current account deficit is determined by some other different kind of mercantile consideration that might generate a set of feedback effects. So, it's harder for me to be confident about what the effect is. But it seems to me the sign is pretty clear that this kind of accelerated environmental investment would operate in the right direction wherever it took place.

Adam Posen: Thank you. Last Friday, in this room, German Finance Minister Olaf Scholz spoke about his push, his desire, for some global agreement or G20 at least agreement on minimum international corporate tax. And we had, a couple weeks ago, a presentation by the IMF Fiscal Department on multinational corporate taxation. Again, this is - not everything has to fit into your one envelope, but from there does seem to be some movement at the G20. Beyond your brilliance in public finance, how should the secular stagnation perspective possibly inform those discussions? Or is that just a separate track we just let it go?

Lawrence Summers: I think it is mostly a separate track. Some of you will have seen my piece in The Post about a week ago, basically arguing that it was not very surprising that the people didn't - that the people out there didn't like globalization very much when they perceived that the agenda was mostly about pursuing particular commercial interests of particular large companies under the guise of the word free trade. When there might be merits, there are merits, to increase intellectual property protection, for example. But they're not actually the merits that are in an economics textbook that explains that free trade is obviously good. And that we have gone quite far beyond Ricardo in the agenda of commercial issues we discuss in trade agreements.

But that it's unfortunate and ironic that the issue of coordination in the tax area so that there isn't large scale avoidance of tax burdens by pitting one jurisdiction against another; has always been a kind of third order issue that never gets the profile or the political attention that trade issues get. And so I think that is a welcome initiative from my point of view.

I don't think it would have substantially adverse impacts on global investment. And as long as the revenue received was spent by governments, it would operate to stimulate demands. And some of the revenue received would otherwise have been saved by corporations or their shareholders, it does suggest as an attractive idea, announcing an initiative of this sort and having some proposal for earmarking the revenue that would be produced to some set of internationally virtuous causes which would make it pro investment and therefore make it responsive to secular stagnation. But I think for the most part it's probably better to think of these things as being on separate tracks.

I would say that as somebody who agrees with about 60 to 65 percent of what comes out of the Peterson Institute and isn't sure whether I agree or disagree because I don't just have a strong opinion about another 25 or 30 percent of what comes out of the Peterson Institute. The paper that came out of the Peterson Institute recently suggests calling into question the merits of international corporate tax cooperation on the grounds that the corporate tax itself was sort of a dubious proposition. I did not find to be an analysis with which I had any sympathy at all. In a world where 80 percent of the shares of US companies are held by entities that do not pay individual tax, seems to me we should be moving beyond the double tax talking points.

Adam Posen: Well, as you know, even within the Peterson Institute we only agree on about 50 percent of its output with each other. So the individuals making their views known should get responses individually from you. Thank you.

Let me go back for a second the monetary policy. So you started off, frankly as I would have as well, with the realities that this isn't just about zero lower bound although zero lower bound is an important operational issue and that if we're thinking about macro response in your contingency planning for recession heading, we have to be thinking about fiscal policy as well as long term. But then you closed with sort of getting off a remark about if we happened to overshoot on inflation so much the better.

Again, that's fine. But I just want to press you. The Fed has undertaken, I think far more aggressively and openly than many people expected, a review of its targets and practices which is ongoing. The current Vice–Chair Richard Clarida has been pretty forward in a number of ideas and recently this was discussed at Fed Reserve Bank of Minneapolis, I think last week, about the idea of the Fed should concern itself with the labor share, which sort of bears some resemblance to some of your discussion about monetary policy, excuse me, moving revenues to those with higher marginal product of consumption. Sorry in my notes, MP, MP, marginal product.

So I mean rather than necessarily have you comment on that specifically, should there be a reconsideration of Fed targets that goes beyond simply saying well we'll leave the 2 percent inflation target there and if we beat it great? Is there anything more that monetary policy can do at this point? Is there something they should be going to Congress and asking for in terms of the capabilities or mandate change? Or is it just its backseat when we get back out of secular stagnation then monetary policy goes back to business as usual.

Lawrence Summers: I think the danger that the Fed will somehow have too loose a set of targets, and too easy a regime and recreate inflation is a remote risk. So almost anything that the Fed decides it wants to do that will tend to push things in a more expansionary direction, I would be very much inclined to support.

I think the biggest existing problem around the Fed right now is, which I'm not sure fits as part of this discussion, I think there are serious concerns that their ability to respond to the next financial crisis with appropriate last resort type lending have been circumscribed by excessive populism in the Dodd-Frank legislation. And I think that runs the risk of exacerbating the next very difficult situation when it comes. And I think that's a high order concern. I am supportive of as strong language as possible emphasizing the desirability of being above two after a period when you're below two.

I am of the general view that these things get reconsidered every 10 or 15 years anyway and so worrying about what the nature of the regime will be for all time doesn't strike me as being a terribly productive concern and I think we will be in the current world of problems for another 10 or 15 years at least.

I am not particularly enthusiastic about forward guidance, which I think is not clear to me that it has any real credibility or efficacy. And I think supposing that it does, reduces the propensity to use other instruments. I'm also kind of skeptical about the efficacy of QE. I don't expect to see it but I would like to see plans made now for more satisfactory coordination between the Fed and the Treasury in the event that we have another zero lower bound episode.

I found, as an American policymaker, the spectacle of the Fed proudly announcing that it was selling short term financial instruments and buying long term financial instruments in order to reduce Term Premia and provide expansion. The Treasury was equally proudly explaining that it was taking advantage of this period of low interest rates to stretch out the maturity structure of the debt. I found that embarrassing as an American citizen. And it seemed to me that the Treasury lengthening the maturity structure while the Fed was shortening the maturity structure simultaneously was giving the broker–dealer community an opportunity to profit handsomely by intermediating between the Fed and the Treasury. And that seemed to me to be quite misguided.

So, planning for greater Treasury–Fed cooperation in the event that we have another zero lower bound episode is something that I think should be part of the Fed's contingency planning.

Adam Posen: Okay, one final question before I turn it over to our audience. And this is also could be arguably monetary fiscal coordination question. You and a number of other leading economists have written about the mistakes or I think Paul Krugman put it Abba Lerner with original errors in the form of MMT, Modern Monetary Theory.

As a shallow Washington policy wonk I can say, well, the eggheads are talking but it sure sounds like Larry Summers is continuing with keep going until you see the whites of the eyes of inflation as you wrote in the FT a few years ago; and go big on funding green investment, which is pretty much where if you do a one line take away, what the MMTs say. So, what's wrong with MMTs if they get to the same policy conclusion and why does it matter?

Lawrence Summers: Here's how I've come to think about MMT and how to talk about this. I go back to an analogy from the other side of the political spectrum 40 years ago. In the late 1970s, there was a combination of experience and economic research that made a case that in thinking about government tax and transfer programs it was very important to think about their incentive effects as well as to think about their transient effects by putting money in people's pockets. And that was an important and valid idea.

And then there were a bunch of goofballs who ran around and said they'd invented a curve and that if you cut taxes it would pay for itself and calling themselves supply side economics. And then the question, how should one respond to the idea of supply side economics. And on the one hand, it really was true that economic thinking and economic policymaking needed to take account of the incentive effects of tax policies in a way that it hadn't before. But it was also nuts to think that the Laffer Curve meant you could cut taxes and have a free lunch.

And I think something similar is the right way to think about MMT today. I think that we do need, substantially, to change our thinking about fiscal policy in light of the need to absorb chronic private sector surpluses and associated low interest rates. But the no free lunch doctrines or the there are free lunch doctrines associated with MMT, are crude and dangerous. And it seems to me that the right posture for people who think of themselves as balanced is to be able to identify as extreme and wrong, doctrines which point in the same direction as beliefs they have at a particular moment. And that's why I've spoken in the way I have about MMT.

Adam Posen: Thank you. So let me turn it over to our audience. We still have some more time with Larry, thankfully. I'm going to ask to group two questions at a time so as to get as many people in as possible. There's a roving mic up front with Tanisha for the first three or four tables. There's a standing mic in the middle of the room. Please when you're recognized, state your name and affiliation and so come on up and please make it a question. We'll invite you back to give a speech if you want to give a speech. Please.

Rich Miller: Rich Miller at Bloomberg. Thanks very much for the presentation. Appreciate it. Simple question. Is U.S. Monetary Policy too tight? And another simple question. Is U.S. Fiscal Policy too tight given what you had to talk about earlier? Thank you.

Lawrence Summers: I think they're probably broadly appropriate now. If you take U.S. monetary policy and its prospects as being represented by the current yield curve which suggests that the next move is considerably more likely to be down than up. That's as far as I would think it should go in an expansionary direction today.

U.S. Fiscal Policy. There's plenty in U.S. Fiscal Policy that I think is quite misguided. The Trump tax cuts used up a substantial amount of fiscal space to exacerbate the income distribution while contributing very little to stimulating either aggregate supply or aggregate demand. And the continuing low level of a variety of kinds of public investments is I think going to be very, very costly in the long run. So, I would favor substantial adjustment of U.S. Fiscal Policy. But if you ask would I either make a major priority of fiscal consolidation or a major priority of fiscal expansion, right now in terms of the aggregate budget, the answer is no I would do neither.

Adam Posen: Okay, next question. There. Tanisha, go to Jacob please.

Jacob Kirkegaard: Jacob Kirkegaard from the Peterson Institute. Thank you for a fascinating presentation. Just a quick question. There's a lot of talk, obviously Europe is the most obvious example, about fiscal rules and broad guidelines for fiscal policy. Is there any way we should think about how the sort of situation of persistent secular stagnation affects that thinking. I mean, directionally, I would think obviously it should. But conceptually, does it affect that discussion.

Lawrence Summers: I am viscerally skeptical of rules as a basis for making policy. They tend to seem better before they're actually implemented. So, to take just one example of the kind of perversity they engineer; nobody in Europe was selling buildings and then leasing them back in a way that was, present value, substantially negative before we started having fiscal rules. But since the fiscal rules took account of debt and the fiscal rules didn't take account of sacrificed income streams in the form of lease commitments, it became very advantageous to do that kind of thing.

So, the combination of the fact that simple rules are gamed and manipulated, and the fact that there are enough unknown unknowns that people can't figure out what their reaction function is going to be because they can't specify the universe of possible things that might happen well enough to specify a reaction function, makes me quite skeptical of the idea of fiscal rules. I think there are more reasons why fiscal rules will work out badly than monetary policy rules. And I think that my reading of the evidence would be that if you'd made a monetary policy rule five years ago, you would've made some rule like the Taylor Rule with a 2 percent intercept and that would have been quite a catastrophic error. And so I'm very unsympathetic to autopilot type rules.

I think there's a closer question about institutions that insulate from politics. But on balance, I don't think I would favor. I don't think I see such an institution in the fiscal policy area. There's softer stuff. If every country in Europe had some equivalent of the CBO and it was monitored by some master CBO in Brussels that would strike me as probably contributing to more intelligent decision making and better fiscal policymaking. So, I'm not against any change but hard core stuff in the form of autopilots, I'm pretty unenthusiastic about it.

Adam Posen: Here, please, Stan.

Stanley Fischer: Larry I sort of naturally as I'm sure many people around this room have thought was what were you going to say today. And let me tell what I think you are going to say and it's perfectly logical. We don't have much in the way of monetary policy. We've just learned that fiscal deficits are much less important than we thought they were. So we should stop relying on monetary policy for short term countercyclical policy and turn to fiscal.

Then I said but fiscal is so awkward and takes so long and is so controversial, that maybe that wouldn't work. And then I suddenly thought well you know you can't change a value added tax by half a percentage point from time to time and you could have a group of people, you know, and I know, Alan Blinder's view that there should be a fiscal which is analogous to the way the Fed operates for fiscal policy. I think that it will never happen because that's what governments think they control but take that along. Aren't you driving? Shouldn't you be driving in the direction of much more fiscal policy?

Lawrence Summers: Perhaps I should be. The reason I didn't say that was not because it hadn't occurred to me. It was a combination of a few things. One, I was emphasizing the kind of long run settings of policy rather than just the countercyclical aspect and the proposal you're describing is more oriented to the countercyclical aspect.

Two, we don't have a value added tax and what we have is the kind of income and a payroll tax. The evidence is mixed on the efficacy of temporary changes in those taxes in terms of how much spending they elicit.

Three, I have always been quite uncertain about intertemporal substitution effect based fiscal policies. I first thought about this when I was a graduate student. And the issue that I thought about then but the same issue arises with respect to your thing, is so you can have an investment tax credit and the idea is it's really going to be terrific. It's going to be a temporary investment tax credit that's only going to kick in during the recessions. And so you'll really get a big bang because everybody will concentrate their investment during the recession, it'll be really stabilizing. It's a great idea.

The problem is that the moment when people will minimize their investment is in the six months before they think the investment tax credit is going to come in; which is exactly the moment when you most want the investment to take place. And so I worry that any, and I know that we tend to be late recognizing recessions and all of that. And so I am not convinced that if you have your variable value added tax, you're not going to have fair sized problems of people delaying replacing the refrigerator just at the moment when you most want them to be replacing their refrigerator because the economy is headed down.

And the fact that some economist who assumes that the GDP is an AR(2) and assumes that you've got rational forward looking consumers can show that even taking account of the intertemporal substitution effect, there's the possibility that it will end up net stabilizing is less than completely reassuring to me as an answer.

And I guess, I think there's a tendency for experts in every area to think that their area is too sensitive and important to be under political control. And so it should be turned over to technocrats like them. And I think like law enforcement's a pretty sensitive thing. Diplomacy is a pretty sensitive thing. Like war's are a pretty sensitive thing. So, I'm not sure that if we let those things be run by the President in the political process; the question of what tax policy we're going to have as the economy heads into recession is somehow so special that it should be removed from the political process.

Adam Posen: Okay. Please.

Stanley Fischer: But then, what you're saying is that the fiscal hope [inaudible 00:31:08] and then we should be somewhat more pessimistic about. Do you want me to start again?

Adam Posen: Well start again. The fiscal hope is not that much greater than anything else we've got.

Stanley Fischer: Yeah, that's the question. And the question is, well, isn't that just bad news or is that something that we've got to keep working on? I don't know.

Lawrence Summers: I think my views are that relative to what I take to be conventional wisdom; I think the economy is substantially more brittle than people suppose. And the risk that the next recession will turn out to be big, because we won't be able to cushion it with monetary policy, because it will call forth a variety of kinds of unfortunate populist and protectionist policy here and around the world and because there'll be difficulties in doing things with fiscal policy. I think those risks are generally underestimated and there is more brittleness so, I am more pessimistic.

That said, I think I would rather put my chips on people learning the right lessons from the fact that the fiscal stimulus was not as large and certainly not as sustained as it should have been in 2009. And acting better in a discretionary way next time, than trying to set up some kind of automatic mechanism or some kind of removal of the issue from politics, which I think is going to be of questionable legitimacy, is unlikely to actually happen, and I'm not altogether sure would be that great, if it did happen.

I have thought about the question, which related to yours, I pushed a bit for temporary sales tax rebates as a strategy in the spring of 2009 and there were devices for extending them to the states that didn't have sales taxes. And my argument was this was a one off thing and it was a really weird thing. So, if you did it this one time it wouldn't be a precedent for the future so you wouldn't have the kind of problem that I was describing, and you might pull forward a lot of spending to a particular moment.

To a Democratic administration that was just taking power with a whole variety of pent up priorities in a variety of areas, the idea that nothing could be done more inspiring to stimulate the economy than giving people a sales tax rebate at the mall was kind of not really thinkable. And so the idea didn't go very far. But I think if I was looking for an idea in this space it would probably be thinking about varying the sales tax.

Adam Posen: Okay, we're over time but our final question.

C. Fred Bergsten: Larry, brilliant remarks.  

Adam Posen: That's Fred Bergsten here at the Peterson Institute and the previous questioner was Stan Fischer from our board of directors. Please.

C. Fred Bergsten: Brilliant remarks. Thank you. Two quick questions on the international dimension. Your remarks focused on half the world economy and the other half of course is the emerging markets of the developing countries. How have they avoided secular stagnation and/or do you fear that they might be infected by it if it continues?

Second, you noted at the outset, that the rich countries, the industrial countries as a whole, have been in current account balance. That means the emerging markets have also been in current account balance. Part of your thrust seems to be that the emerging markets ought to start running substantial deficits, which would be a good thing for development probably as well. So would it be helpful to frame it in those terms in addition to the things you said which implicitly went in that direction.

Lawrence Summers: So, I spoke less bluntly and clearly that is my norm, if you didn't hear me as saying your second thing. So, I was trying to say that the world should organize itself to have there be a flow of capital from north to south so that the developing countries are running a current account deficit. I might just mention as something that puzzled me as I did this that; if you look over about 20 years, the aggregate current account deficit of the OECD fluctuates very, very little, it is about zero. And as you point out a [Inaudible 00:36:50], the same thing is true for emerging markets, even though the current account deficits of individual countries fluctuate a ton.

And so the question I was led to ask myself is, is it just a statistical coincidence that in a world of lots of fluctuation, the aggregate has been so constant and so close to zero. Or is there some deep force going on that I don't understand that accounts for that kind of conservation law and I have fished for a good explanation for why that conservation law should be true and I've not heard one. And so I'm inclined to think it's just a statistical coincidence of these 25 years. But I think it's an important question.

Why haven't emerging markets had secular stagnation? I guess it's because they are capital light and so they've got a lot more room to build up their capital stocks. They have historically had more rapid demographic growth. They have in a variety of cases been fiscally profligate as one would judge things from the perspective of an industrial economy.

And I have not found, maybe this is the most important thing I'll say in answer to your question; I haven't found the right words, the right way to kind of talk about this so I understand it. It seems ludicrous to apply the word secular stagnation to China but I'm not so sure it's ludicrous to apply the words under consumption challenge to China. If one thinks about it, China has a national savings rate that's roughly comparable to the one the United States had during the Second World War.

And that does mean that in order for them to be at full employment, they either have to be investing on an immense and potentially wasteful scale or they have to be net exporting. And so in many ways their economic management problem is not unrelated at all to the problems we've been describing of a kind of over saving and associated problem of absorption. And so it's not quite right to say that no emerging markets have problems of this kind.

Adam Posen: On that promising note for research and future discussion if not for saving the world, I will close this session. Please join me in thanking Lawrence Summers.