Larry Summers' blog

Monetary policy should seek to avoid major surprises


In recent writings, I have laid out the strategic case against the Federal Reserve tightening this week. There is a compelling tactical case as well.

Monetary policy should seek to avoid major surprises.  Right now the fed funds futures market is assigning only a 28 percent chance to a September tightening. In the last 20 years, the Fed has never tightened without guiding the futures market to at least a 70 percent chance of a tightening.  So a move now, given how expectations have been managed, would be an extraordinary shock at a highly uncertain time.

To find a relevant precedent, one has to go back to 1994, when the Fed raised rates by 25 bps despite the market assigning only about a 30 percent chance (around what is expected now) of a tightening.  What followed was dubbed by Fortune Magazine as the Bond Market Massacre.”  Over the ensuing nine months, the interest rate on the 10-year bond rose by 2.2 percentage points — nearly twice as big an increase as any subsequently — with mortgage rates rising in tandem.   Volatility spiked dramatically across the world, and Orange County had the then-largest municipal bankruptcy in U.S. history.  Mexico and Argentina moved towards financial crisis.

There is a point here quite separate from the issue of what monetary policy should be.  Communication is a key part of the art of monetary policy.  The Fed for a generation has caused its tightening moves to be anticipated because it learned from the 1994 experience.   The same approach should be taken going forward.  Even if it were otherwise a good idea to tighten, no adequate predicate has been laid for a rate increase this week.


Why Ukraine’s debt deal is important not just for Ukraine, but for the West


I have spent the last two days in Kiev attending the Yalta European Strategy meeting, where I have had the chance to discuss Ukraine’s economic reform efforts with key officials, including the finance minister and prime minister.  I was encouraged to see a country where, despite huge challenges, including Russia’s war of aggression against Ukraine, economic reforms are being carried out and receiving support from the international community.

The Ukrainian parliament will this week vote on a historic debt reduction agreement that finance minister Natalie Jaresko negotiated with Ukraine’s private-sector creditors. The case for approval is overwhelming, both because Ukraine has made a good deal and because disapproving the deal would be catastrophic for Ukraine’s economy. But approval of the debt deal is only one component of the ambitious economic cooperation among Ukraine, Europe and the United States – cooperation that is essential to the geopolitical moment.

I have been watching debt negotiations closely for more than 30 years, since the Latin American crisis of the 1980s. Ukraine has gotten as good and fast a deal as any I have ever seen.

The deal has many virtues:

  • It reduces the principal value of Ukraine’s debt and eliminates principal payments for the next four years.
  • It unlocks substantial support from the International Monetary Fund and other international financial institutions on a large-scale.
  • It brings forward the day when Ukraine can attract significant private capital flows.
  • It establishes clear principles that will enable Ukraine to defer all principal payments on its obligation coming due to Russia.

Even if Ukraine’s economy does very well, the “value recovery instrument” issued as part of the debt deal, which aligns debt repayment with economic growth, is shrewdly designed so that the vast majority of future growth will still flow to the Ukrainian people, not to its creditors. This is because: (i) the instrument only kicks in at scale in a decade; (ii) it is subject to repurchase on the open market and to subsequent renegotiation; and (iii) it is carefully designed to ensure that only the initial benefit and not the continuing benefit of Ukraine’s growth flows to creditors.

In the unlikely event that Ukraine’s parliament disapproved the deal, all these benefits would be lost. International financial support would dry up as Ukraine would be seen as unable to carry through on commitments. Confidence in the stability of Ukraine’s currency and banking system would be put at risk. And its leverage vis-a-vis its debt to Russia would vanish.

So I hope and expect that the Ukrainian parliament will ratify the debt deal in the very near future. To paraphrase Churchill, this may not be the end, or even the beginning of the end of Ukrainian economic reform, but it may be the end of the beginning.

Make no mistake – the United States and Europe have an immense stake in Ukraine’s economic success. Our leaders rightly assert that military force is often not the right solution to international conflict. Enabling Ukraine to provide greater improvements in living standards for its citizens than Russia does would be a major triumph for the West. In this regard what we do for Ukraine is likely more important than what we do to Russia.

Support for Ukraine should not be seen as foreign assistance to a striving economic reformer, though it is that. Rather, with Ukraine invaded, support should be seen as investment in forward defense of core U.S. and European security interests. If Ukraine succeeds economically, investments will pay for themselves several times over as loans are paid back with interest, and as Russia’s government is both deterred by Ukraine’s stronger economy and pressured by its economic example.

Historians will wonder why the international community has invested more than 10 times as much money in supporting a recalcitrant Greece as in supporting a reforming Ukraine, since the start of their crisis.  Perhaps intra-European Union loans are in some special category, but as of this moment the IMF’s potential exposure to Greece is $41 billion compared to only $22 billion for Ukraine.

Now is the moment for Ukraine at long last to embrace the market and the rule of law.  It has the best, most market-oriented economic team in its history. And it is the time for global community to do whatever it takes—much more than is being done today—to provide support at a critical juncture.


Thoughts on Freeman’s Bargaining for the American Dream


Yesterday, I participated in a Center for American Progress forum where a new study on unions and social mobility was released. The study, by my Harvard colleague Richard Freeman and collaborators, showed a significant correlation across American metropolitan areas between the extent of union membership and social mobility. Freeman, who based his research on data in the famous studies of Raj Chetty and his collaborators, also showed that the children of union members earn higher wages and are healthier than other children.

This is important work. From Ted Cruz to Bernie Sanders, there is agreement across the political spectrum that equality of opportunity is an American ideal — that Thomas Jefferson was right in saying that America should be an aristocracy of talent. Yet equality of opportunity in the U.S., no matter how measured, lags behind other countries and certainly has not progressed over the last several decades.

Chetty’s celebrated “equal opportunity map,” reproduced below, shows that there are no grounds for fatalism. Different parts of the U.S. deliver very different levels of social mobility, while all in the same global economy, with the same technology, and the same increasing proclivity of able men and women to marry each other. There is nothing immutable about the existing inadequate level of equal opportunity.


The map demonstrates that equality of opportunity is particularly bad in the old confederacy and particularly good in some of the old bastions of abolitionism. It is not therefore surprising that unions, which were concentrated in the North, turn out to be correlated with equal opportunity. More impressive is the research result that looking across families, fathers who are union members have children who earn at least 15 percent more than those who are not in union families, and that this stands up even with various control variables added. The implication is that supporting unions not only helps workers who are members themselves but also helps their children and communities as well.

Few people believe that private unions in the United States had excessive power in the 1970s. Yet the share of private sector workers in unions has fallen from over 24 percent in 1973 to under 7 percent today. Unions are surely too weak today. Their weakness most clearly shows up in workers who have difficulty maintaining a middle class lifestyle. In a more profound way, the weakness of unions leaves a broad swath of the middle class largely unrepresented in the political process, paving the way for the kind of disillusionment that has driven the Trump candidacy. After all, no society is going to remain stable and confident in its central institutions if parents do not believe their kids can lead better lives than they did.

In 2009, at the Brookings Institution, I spoke about the important role of unions in generating broadly shared growth. I said, “If we want to propel this economy forward and we want to have a sound expansion, it has to be an expansion whose benefits are more broadly shared. And that goes to the question of tax policy and progressivity, it goes to the question of education over the longer term, and it goes to the question of having a healthy and well-functioning trade union movement.”

Broadly shared prosperity is even more elusive today, so what is needed going forward? I would suggest three important steps.

First, we need serious enforcement of laws to stop employers from punishing workers seeking to engage in collective action. Enforcement has historically lagged badly as it typically takes at least four and often as many as seven years for cases to be decided. And even if employers are eventually found guilty of violating the rules, the penalty is generally under $10,000 per harmed worker. Anti-union employers can violate the law with near-impunity worrying only about slaps on the wrist years in the future. As Morris Kleiner and David Weill found: “expected costs [for being found guilty of violating labor laws] represent a fraction of the benefits to employers … from thwarting organizing drives. It is therefore not surprising that there has been a sevenfold increase in the percentage of violations of the act”.1

Second, the union movement needs to expand on its efforts to build models of collective action that are not rooted in traditional command and control corporation. This may include increased emphasis on profit sharing, on labor management dialogue, on industry wide bargaining, and many other ideas as well. Organized Labor needs to adapt to the pervasiveness of white collar, pink collar, and no collar work in addition to traditional blue collar work.

Third, there is a compelling case even if it does not appear politically realistic right now for labor law reform to give more scope to those seeking to organize workers. There are detailed agendas of possible reform. What is important now is that a consensus form around the idea of reducing burdens on union organizers.

Thanks to the work of Freeman and his collaborators, we now know that stronger unions are not just good for their members, they are good for our country and our descendants. Strengthening collective worker voice has to be an important component of any realistic American inclusive growth agenda.




Why the Fed must stand still on rates


Two weeks ago I  argued that a Federal Reserve decision to raise rates in September would be a serious mistake.  As I wrote my column, the market was assigning a 50 percent chance to a rate hike. The current chance is 34 percent. Having followed the debate among economists, Fed governors and bank presidents I believe the case against a rate increase has become somewhat more compelling even than it looked two weeks ago.

Five points are salient.

First, markets have already done the work of tightening.  The U.S. stock market is worth $700 billion less than it was 2 weeks ago and credit spreads have widened noticeably.  Financial conditions as measured by Goldman Sachs or the Chicago Fed index have tightened in the last 2 weeks by the impact equivalent of more than a 25 BP tightening.  So even if resisting inflation required a 25 BP tightening as of two weeks ago, this is no longer the case.

The figure below makes a crucial point.  It shows that even though the federal funds rate is very low (negative one and a half percent after adjusting for inflation), financial conditions are helping the economy less than in previous years when interest rates were much higher.


Second, the data flow suggests a slowing in the U.S. and global economies and reduced inflationary pressures.   Employment growth appears to have slowed down, commodity prices have fallen further, and the general data flow has been on the soft side.  Comprehensive measures of data surprises, such as the Bloomberg Economic Surprise Index, bear out this impression and the Atlanta Fed’s GDP Now model is currently predicting only 1.5% growth in Q3.

Third, the case for concern about inflation breaking out is very weak.  Market based expectations suggest that inflation over the next decade on the Fed’s preferred core pce basis is near record lows and well below 2 percent.  The observation that 5 year inflation, 5 years from now is expected to be below target calls into question arguments that current low inflation is somehow transitory.

The recent analysis presented by Fed Vice Chair Stanley Fischer asserting to the contrary relies on assumptions about exchange rates and inflation.  When actual empirical estimates are used his conclusions are substantially weakened.  Indeed as the figure below shows, there is no correlation of late between deceleration in inflation and import share looking across PCE components.InflationAndImportSharePCE.xlsx

Also on inflation, it bears emphasis that (i) we have some room for inflation acceleration (ii) prices are now fully 2 percent below a 2 percent inflation path taking off from 2010, (iii)  the Phillips curve is so unstable that it provides little basis for predicting inflation acceleration.  To take just two examples — first, unemployment among college graduates is 2.5 percent yet there is no evidence that their wages are accelerating. And unemployment in Nebraska has been below 4 percent for the last 3 years and growth in average hourly earnings has been basically constant at the national average level.

Fourth, arguments of the “one and done” variety or arguments that the Fed can safely raise rates by 25 BP as long as it’s clear that there is no commitment to a series of hikes are specious. If as some suggest a 25 BP increase won’t affect the economy much at all, what is the case for an increase? And when the same people argue that 25 BP will have little impact and that it is vital to get off the zero rate floor, my head spins a bit.

In a highly uncertain world, the Fed cannot be both data dependent and predictable with respect to its future actions. Much better that it stick with data dependence than that it put its credibility at risk by seeking to mitigate a current rash action by trying to reassure with respect to future steps.

I understand the argument that zero rates are a sign of pathology and the economy is no longer diseased so policymakers have to increase rates.  The problem is that the case for hitting the brakes in an economy with sub-target inflation, employment and output is not there; regardless of whether the brakes are to going to be pressed hard or softly, singly or multiple times.

From the Vietnam War to the Euro crisis, from the Iraq war to the lessons of the Depression we surely should learn that policymakers who elevate credibility over responding to clear realities make grave errors.  The best way the Fed can maintain and enhance its credibility is to support a fully employed American economy achieving its inflation target with stable financial conditions.  The greatest damage it could do to its credibility would be to embrace central banking shibboleth disconnected from current economic reality.

Fifth, I believe that conventional wisdom substantially underestimates the risks in the current moment.  It bears emphasis that not a single post war recession was a predicted a year in advance by the Fed, the Federal government, the IMF or a consensus of forecasters.  Most were not recognized till long after they started.  And if history teaches anything it is that financial interconnections are pervasive and not apparent till it’s too late.   Russia’s 1998 default, problems in subprime lending, and the Asian financial crisis were all moments when financial dislocations had far more pervasive effects than was generally expected.

We know that the world’s largest economy, China, is in its most uncertain state since it began economic reform in 1979 and may well be experiencing a larger volume of capital flight than any economy in history.  We know that the central banks  of Japan and Europe are likely to have to double down in the months ahead on already extraordinary quantitative easing.  We know that American households, firms and markets are processing what appears to a kind of “reverse 1990s” moment of sharply decelerating productivity growth.  We know that liquidity conditions in markets have worsened and there is at least some reason to believe that “positive feedback” trading strategies where investors sell when prices go down may well have become increasingly important.  We know the current U.S. recovery is in its 7th year and that confidence in public institutions is at a low ebb.

More likely than not, these fears are overblown and 2015 and 2016 will not go down in financial history.  If so, and the Fed does not act, inflation will start to accelerate, volatility will subside and policy can step in.  Regret may come in the form of inflation a few tens of basis points too high or a bit of euphoric relief in markets.  If on the other hand, some portion of these fears are warranted and the Fed tips towards tightening, it risks catastrophic error.

Now is the time for the Fed to do what is often hardest for policymakers.  Stand still.

September 9, 2015


Larry’s new blog


Over the summer, I have expanded my website to include a new blog that will enable me to comment on economic policy issues and current events more generally.  I will continue to write my monthly Financial Times/Washington Post column, and their websites will also feature my blog content.  This blog will enable me to address issues immediately, informally, and at varying lengths and to pose questions that I think economists have inadequately considered.   It will also provide an opportunity to disseminate various commentaries and discussions that I present at conferences.

As I have often noted, policymakers in political environments are most constructive when they find approaches that are appealing from a variety of perspectives and command widespread support.  Academics, on the other hand, are most useful when they provoke thought and debate and present new approaches.  In that spirit, I will regard this venture as successful only if it incites disagreement and debate.  My goal will often be to expose fallacy or misguided opinion.  However, I shall never try to impugn the motives of those with whom I disagree.

Comments and questions are welcome, but we will only be able to select a few to post with each blog.  I may, from time to time, respond to questions or comments in a new blog posting, but will not be able to respond to each individual comment received.

I hope you will find some interesting ideas in this new blog and share it with your colleagues and friends.


Thoughts on Ukrainian Debt Restructuring


I was very glad to see Ukraine reach a deal involving reduction in the principal value of its debt with major creditors. This would not have happened without the tenacity and determination of Ukrainian finance minister, Natalie Jaresko, and Ukraine’s political leadership. Congratulations also to the IMF and the U.S. Treasury for their strong efforts. continue

The Astonishing Returns of Investing in Global Health R&D


By Lawrence H. Summers and Gavin Yamey

How to reach a “grand convergence” by 2035

We have a once-in-human-history opportunity to achieve a “grand convergence” in global health—a reduction in infectious, maternal, and child deaths down to universally low levels everywhere on the planet. continue

Tomorrow Greece votes


Tomorrow Greece votes. No one can know the outcome yet. Indeed, my bet is that a third of the voters are not yet sure how they will vote. If polls could not get the British election right, I doubt that they can get this one right. Anything can happen, and it would not surprise me if the vote is a landslide, one way or the other. continue

Comments from ECB Conference


I commend Mario Draghi and the ECB for their openness in hosting this conference and allowing the presentation of so many perspectives. In the spirit of that openness I shall offer some iconoclastic observations. continue

Feldstein Argues Price Indices Underestimate Real Income Growth


Yesterday, in the Wall Street Journal, Marty Feldstein argues reasonably that conventional price indices underestimate real income growth because they take inadequate account of quality improvements and new products.  Marty asserts very plausibly that properly measured real incomes and wages have not been completely stagnant in recent decades. continue

Rethinking Secular Stagnation After Seventeen Months


IMF Rethinking Macro III Conference

I am glad to be here and I salute Olivier (Blanchard) and the IMF for so open a dialogue on so wide a range of macroeconomic hypotheses. What I want to do this morning is talk about three things: I want to tell you why I think that the risk of secular stagnation is an important problem throughout the developed world. I want to contrast the secular stagnation viewpoint with two views that I regard as heavily overlapping – the debt super‐cycle view that Ken Rogoff put forward and the savings glut view that Ben Bernanke has put forward – and explain why I think they’re very similar, but insofar as their nuances of difference, I prefer the secular stagnation view. And then I want to reflect on the policy implications of this general view of the global economy over the next decade. continue

On Secular Stagnation: A Response to Bernanke


Ben Bernanke has inaugurated his blog with a set of thoughtful observations on the determinants of real interest rates (see his post here) and the secular stagnation hypothesis that I have invoked in an effort to understand recent macroeconomic developments.  I agree with much of what Ben writes and would highlight in particular his recognition that the Fed is in a sense a follower rather than a leader with respect to real interest rates –  since they are determined by broad factors bearing on the supply and demand for capital – and his recognition that equilibrium real rates appear to have been trending downward for quite some time.  His challenges to the secular stagnation hypothesis have helped me clarify my thinking and provide an opportunity to address a number of points where I think there has been some confusion in the public debate. continue