In Memoriam Dick Spangler

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My friend Dick Spangler died this week. He was a great supporter of Harvard and a very good friend to me. I feel his loss in a profound way.

I met Dick when he was a member of Harvard’s Board of Overseers and I became President. In a group of distinguished people, Dick was a towering figure. He contributed more to Harvard than anyone else;  he had more experience as a higher education leader than anyone else; he worked harder than anyone else reaching out often to people a third of his age. He was wise, pithy and clear in all his statements.

Dick was a very good friend to me. During my time as Harvard president he taught me much about treating people right, about fundraising, about setting priorities and about leadership. I’d have been better off if I had followed more of his advice.

Knowing Dick, I was not surprised to learn from his obituary that he had been a hero for civil rights, civility and public schooling in North Carolina. He was a business leader who understood (as many do not) business’ dependence on the broader society.

In the last long decade I saw Dick only every couple of years. He would drop by my office when he was visiting Harvard. He would always insist on waiting while I finished up a conversation with a stray sophomore. Then we would talk about Harvard, politics and family. As I became more involved in the business world, he gave me some of the best advice I have ever received.

Dick Spangler may be gone but his influence will endure through the many people he made better. I am proud to have been his friend.

A jobs guarantee — progressives’ latest big idea

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The impulse behind the latest “big” progressive idea of creating a federal job guarantee is entirely valid. Studies show that those without jobs are much more likely to be dissatisfied with their lives, to become addicted to alcohol or drugs and to be abusive within their families than even those working at low wages they find inadequate.

On this point, the U.S. economy is falling short of its potential. The fraction of the adult population between ages 25 and 54 that is working or seeking work has declined over the past 20 years. Despite America’s vaunted labor-market flexibility, the chance that a 25- to 54-year-old man will be out of work is much greater than it is in France and not very different than what it is in Spain . And in sharp contrast to the rest of the world, the fraction of adult women working in the United States has been declining since 1999 .

These trends are important causes of the increasingly bitter nature of U.S. politics and of resistance to technological change and overseas trade. President Trump received disproportionate support in parts of the country where joblessness increased most.

If the United States could guarantee jobs in even a modestly efficient manner and in a way that significantly increased employment, it would be a very good thing. I want to be enthusiastic about job-guarantee proposals. But at a time when cynicism about government runs strong, it is important for progressives to avoid making promises that they cannot keep. We must rigorously examine the practicality of a job guarantee.

A first question is how much to pay. A program of last-resort employment could likely provide the minimum wage and low benefits. But that will not help those laid off from highly paid manufacturing jobs or those who expect to earn wages well above the poverty line. While such a proposal could help many young people, it is far from clear that it would connect with the principal concerns of Rust Belt adults.

On the other hand, if the guaranteed jobs paid premium wages, say double the $7.25 per hour national minimum wage, they would be an attractive alternative for a quarter or more of the workforce, raising questions of cost and economic disruption.

Suppose a $15 per hour guaranteed job drew 4 million additional people into the workforce and also attracted 10 million existing employees, just one quarter of those for whom it would represent a wage increase. The cost, once benefits, materials and supervisory needs are included, would, conservatively, be $60,000 per worker. That would increase government spending by $840 billion — one-fifth of the current federal total. If wages for the 30 million lower-wage workers who remained in the private sector went up by just $4 per hour, private-sector costs would rise by $240 billion. The burden would largely fall on small businesses and disproportionately hurt restaurants and other major employers of low-wage labor.

A second question job guarantees raise is what all these new workers would do. The current federal government civilian workforce comprises 2 million people . Meaningfully increasing employment or offsetting adverse trends even if all hired came off the sidelines of the workforce through a jobs program would require boosting the federal workforce by at least 50 percent.

The United States has large needs, for example in infrastructure and care of the aged. At the federal level, these are met through contracting, not direct hiring. Using an employment guarantee to address these national problems would require significant restructuring of the way services are provided, likely with an efficiency cost.

A final question concerns the macroeconomics of a jobs guarantee. If the Federal Reserve saw the budget deficit expanding substantially, a tightening of the labor market or upward pressure on wages, it would probably respond by raising interest rates significantly. This would discourage spending and offset the employment gains from a guarantee scheme. If, on the other hand, the program was financed with new taxes, demand from those who paid the taxes would go down. That would reduce private-sector employment and offset the gains from an employment guarantee.

It would be terrific if these questions had persuasive answers. But right now, I am inclined to think that the idea of a jobs guarantee should be taken seriously but not literally. A combination of wage subsidies, targeted government spending, support for workers with dependents, and increased training and job-matching programs represent a more viable strategy for meeting demand for guaranteed employment.

 

Remembering Julio Rotemberg

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Thank you very much to the organizers of this symposium for giving us all an opportunity to remember Julio Rotemberg and his many contributions and for giving me an opportunity to speak about a close friend who for me embodied the best in a scholarly life.  I cherished our friendship and so admired his example.

Start with this.  I knew Julio for a long time.  We met when he came to MIT as an assistant professor in 1980.  When his children were small, and I didn’t yet have children, I spent much time with him Annalise, Veronica and Martin.  With periods of more and less intensity Julio and I maintained our friendship for nearly 40 years.

In all that time, I never heard him say a petty or an envious or a nasty thing.  To be sure, he said things with which I disagreed but I never heard him gossip nastily, run down the work of another scholar, claim that he was being denied deserved credit for some contribution, suggest that someone was overrated or otherwise traffic in what is too often a large part of informal interaction among economists.  I suppose he must have had his ambitions but the only ones that I ever saw were to say things that were new and interesting and helped us understand the world better.

Another thing that stands out for me when I think about Julio was the generosity and capaciousness of his intellectual spirit.  He was not always right.  I am not sure that seeking to rehabilitate Latin American populism was a great impulse.  But there was no idea that he would not entertain, no hypothesis he would not consider, and no subject he would not address.  Over the years we discussed everything from the right maturity structure for US Treasury debt to how Harvard could procure more efficiently, from how committees could best make decisions to what history of thought economics graduate students should learn, from the physics of pumping a swing to the merits of dynamic stochastic general equilibrium models.

Julio gave me a great gift. If I thought a subject was interesting or I wanted to understand it better, that was enough.  He would turn his mind to the issue.  He would help me articulate the impulse that I had and then note the good reasons it was unlikely to be shared.  He was always smiling.  And one other thing stood out for me.  I have had my ups and downs over the years.  It did not affect one bit how Julio related to me.

Julio spent the last two decades of his life at the Harvard Business School.  He loved it and no aspect more than the case method.  I remember when I first became Harvard President, Julio invited me to participate in a class on Business and Government in the International Economy—the course he taught for many years.  The case under discussion addressed capital controls that Malaysia had imposed in the summer of 1998.  It had been written by Laura Alfaro who was then an assistant professor and referred to events I had been very involved in during my time at the Treasury.

I was outraged by the case.  From my perspective, the capital controls had enabled unjust imprisonment and beating of a Malaysian finance minister who had been my friend.  The controls who were imposed the day before my friend was fired and jailed so that his imprisonment couldn’t lead to capital outflows and economic instability.  It seemed to me that this was an unjust totalitarian act that should not be dignified by academic debate.

Julio responded in two ways.  First, with uncharacteristic sternness he said to me: “Larry, you can yell me at me as much as loud and as long as you want.  But Laura is an assistant professor without tenure here and you are President of the University so you are not going to attack her work.”  He then continued:  “You have just the reaction I hoped you would have.  The Malaysians think the case is way unfair to their perspective.  If both sides are mad, that means we wrote a great case.”

He was right on both counts.

His devotion to his teaching was never as clear as in the last weeks of his life. He knew his remaining time was short and there was nothing he wanted to do more than to spend time with his family, and to write one last case and teach one last course.  Thanks to Rafael Di Tella, he was able to teach a that last course.  And he finished the case—attacking my views on the need for more infrastructure investment in the US.  I learned from what he wrote, even if I was not totally persuaded.  And I so admired the way even when in obvious pain, he pushed me to articulate my argument as clearly as possible so he could refute it in its best version.

Julio was a wonderful scholar.  But he was an even better husband, father and friend.  I have so many fond memories of time with Julio and Annalise.  In the early years, my wife and I used to go skiing with the Julio and Annalise.  That does not exactly capture it.  More accurate would be to say we purchased lift tickets at the same resort.  We would then “ski together” which meant we would identify a run to be traversed.  Julio and Annalise would cover the ground three times on the steepest descent while I would struggle down the long crisscrossing horizontal way.  Julio was never impatient or frustrated just mildly amused.

Then there was hiking where I lived in terror at the slopes he would get me on.  I used to remind him that I hiked with my legs not with my hands and that if a trail required the use of hands, it was not for me.  He would always agree and then choose a trail that was just hard enough that I have two moments of terror and cursing on the way up and down and then a real sense of satisfaction afterwards.

And he was so devoted to his children.  I remember his saying to me a couple of years ago.  “Martin has six great ideas.  It would be so great if he could finish and write up at least one of them.  But I can’t say that to him.  Can you?”  I was happy to try to help.

Julio Rotemberg was as good a man as I have known.  I will always miss my friend, even as I am sustained by his memory.

Donald Trump’s trade policy violates every rule of strategy

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Donald Trump has put aggressive trade policy at the centre of his approach to the economy. No other economic subject has received such sustained presidential attention or generated so much controversy.

This is problematic as most economists agree that changes in trade policy are unlikely to have a big effect on growth in employment or over gross domestic product and that liberalising trade is likely to do more for US prosperity than managing trade.

But take as a given the US president’s mercantilist premise that the central priority of American economic policy should be achieving more fairness in opening up markets around the world. Even given this dubious judgment about ends, the US is proceeding in a remarkably unstrategic and ineffective way. Indeed it is violating almost every strategic canon.

A first rule of strategy is to have well defined objectives so that success can be judged and your negotiating partners are not confused about what you want. Is the US’s primary objective to reduce its trade deficit overall or just with particular countries? Is it to protect employment in politically sensitive sectors such as steel and automobiles?

Is it to stop commercial practices such as joint venture requirements that unfairly penalise American companies doing business in foreign countries? Is it to gain more market access for US companies regardless of how successful they are likely to be, as in the case of increased access for the US auto industry to the Korean market?

From tweet to tweet, and senior official to senior official, it is impossible for anyone to know what this administration’s priorities are. When everything is presented as a top priority, as often seems to be the case, nothing can really be a top priority. No one can be confident that making concessions will resolve disputes. After all, when China’s current account balance was approaching 10 per cent of GDP, it was a priority for the US to bring it down sharply. Today it is running below 1.5 per cent of GDP and America is more truculent than ever towards China on trade.

A second rule of strategy is to unite your friends and divide your potential adversaries. The US seems to be doing the opposite. Surely, China stands out as a competitor in terms of economic scale, growth, extent of government economic intervention and in areas such as artificial intelligence.

Yet, after alienating its Asian allies by pulling the plug on the Trans-Pacific Partnership, the US enraged all of its G7 allies with the imposition of tariffs on steel and aluminium as well as making further threats that have caused them to doubt the US commitment to the rule of law in global trade.

As with the Obama administration’s disastrous initial shunning of the China-led Asian Infrastructure Investment Bank, the result has been to cause most of the rest of the world to take China’s side against the US.

Decades of sustained efforts to foster a benign relationship with Mexico are also being squandered. The current US approach to Mexico could hardly be better designed for the objective of electing a leftist radical as president.

A third rule of strategy is to use as leverage threats that are credible in the sense that they do more damage to those you are negotiating with than they do to you. “Stop or I will shoot myself in the foot” is a singularly ineffective threat.

The recently imposed tariffs on steel fall into this category. The US has fewer steelworkers than it has manicurists. The market value of the US steel industry is about 0.1 per cent of the stock market. Yet steel is a key input into industries throughout the economy that employ about 50 times as many people as the steel industry does and compete internationally.

By raising the price of steel the US hurts much more of its economy than it helps. Why does the White House think this counts as leverage against the nations it competes with? Especially when in all likelihood they will retaliate in highly strategic ways, with international legal support, by limiting imports from key US industries.

President Trump’s trade policies will raise the prices Americans pay for what they buy. They will reduce the competitiveness of the US economy. They will succeed where our traditional adversaries have failed in uniting much of the rest of the world in opposition to us. They will reduce our legitimacy and power by demonstrating our lack of competence. The sooner they are radically revised the better off the US and the rest of the world will be.

June 5, 2018

Speech to the Economic Club of New York

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Summers spoke to the Economic Club of New York on May 16, 2018. Watch the video here:

The threat of secular stagnation has not gone away

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The economy is prone to sluggish growth — if the past few years are anything to go by

May 6, 2018

Unemployment in the US is below 4 per cent and growth in the economy is accelerating. By recent standards growth in Europe and Japan is also strong. In these circumstances many believe the idea of secular stagnation can be written off.

Certainly if the phenomenon is defined as the fatalistic view that the economies of the industrialised world are condemned to suffer permanent stagnation with high unemployment, then we are obviously not in a moment of secular stagnation.

However, this is not what Alvin Hansen intended when he coined the phrase, nor what I had in mind when I sought to revive the concept in 2013. Rather the idea of secular stagnation is that the private economy — unless stimulated by extraordinary public actions especially monetary and fiscal policies and, or, unsustainable private sector borrowing —will be prone to sluggish growth caused by insufficient demand.

On this interpretation, the past few years have confirmed the hypothesis.

In the US the Congressional Budget Office forecast, which is comfortably in the mainstream, calls for annual growth of 2.5 per cent over the next three years with growth of 3.3 per cent during 2018. But what is necessary to support this growth? As far as fiscal policy is concerned, the CBO projects growth in actual budget deficits of more than 1 per cent of gross domestic product in 2017-2019, with substantial further increases over time and the most rapid increase in the debt-to-GDP ratio during peak business cycle times than has ever been seen in peacetime.

In terms of monetary policy, indexed bond markets imply that real interest rates will be kept well below 1 per cent for the next 30 years. Meanwhile the economy has been supported by a stock market that has returned 22 per cent in 2017 and an average of 16 per cent over the past five years. This while private sector debt has grown relative to GDP.

If budget deficits had been at normal levels and not growing relative to the economy, real long-term interest rates had been steady in their customary range above 2 per cent and an extra $10tn in wealth had not been created by abnormal stock market returns, it is hard to believe that the US economy would be growing much at all. And it is almost inconceivable that it would be near its 2 per cent inflation target.

Elsewhere in the industrial world Japan’s economy is supported by a government debt-to-GDP ratio that hovers around 250 per cent and long-term real rates of less than minus 1 per cent. Europe has seen a reduction in the ratio of government debt to GDP in recent years but like Japan has received extraordinary stimulus from sub minus 1 per cent real interest rates and increases in the flow of private sector credit. Even with this stimulus Europe and Japan have struggled to achieve 2 per cent inflation.

What we are seeing is the achievement of fairly ordinary growth with extraordinary policy and financial conditions. Something similar took place in the years before the Great Recession.

Whether this is sustainable depends on several factors, not least whether private sector demand will autonomously increase as the financial crisis recedes so growth can be maintained with less unorthodox policy and exuberant financial conditions. Perhaps it can, but it is more likely that a combination of rising inequality, slow labour force and productivity growth, and greater competition from developing countries will keep private sector demand subdued.

There is also a question over whether the current policy mix and financial conditions can be maintained indefinitely. This is doubtful for fiscal policy especially in the US. Monetary policies involving low or negative real interest rates may be sustainable over the long term but they are likely to encourage financial risk, unsound lending and asset bubbles with potentially serious implications for medium-term stability.

The greatest concern remains over whether the next downturn can be handled. Traditionally the response to recession in the industrial world has been fiscal expansion and a 500 basis point cut in interest rates. But the fiscal cannon has already been fired in much of the industrial world leaving policymakers short on ammunition.

So secular stagnation as an issue remains very much alive. Current palliatives are appropriate but unlikely to be long-term solutions. The industrial world can hope that investment demands increase and saving needs decline. But policymakers must turn their attention to demand as well as supply issues going forward.

How to actually help Puerto Rico

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Desmond Lachman, Brad Setser and Antonio Weiss have written a strong analysis of the Puerto Rico situation. If ever there was a disconnect between underlying reality and what is happening in financial markets, it is the boom in Puerto Rican debt which has nearly doubled the value of some of its debt securities over the last few months. Read more

Donald Trump trade threats lack credibility

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April 8, 2018

US bluster has caused most of the world to rally to China’s side

As the possibility of a trade war between the US and China looms, threats and counter-threats are hurled back and forth and markets gyrate, economic logic and truth appear to be an early casualty. There are certain points of fact on which there should be no disagreement.

First, globalization and trade have caused significant disruption to the US economy but this has had little to do with trade agreements of the last generation. It is now clear that increased imports especially from China have inflicted substantial burdens on manufacturing workers, particularly in the the north central part of the country. Where too much conventional analysis goes wrong is in attributing this to trade agreements and in failing to recognize offsetting job gains from exports.

The reality is that the US economy was largely open by the 1980s and that every major trade agreement has reduced other nations’ trade barriers by far more than it altered any American trade barriers. This is most true of China’s 2001 accession to the WTO, in which the US only committed to continuing to keep its markets open on the most favorable nation terms that had already been ratified each year for more than a decade but won major changes in Chinese economic policy.

The real reason for economic disruption was not trade agreements but the emergence of emerging markets as major participants in the global economy. This is not something the US could stop or, given its export interests and broader interests in global co-operation, could plausibly aspire to contain.

Second, much of President Trump’s rhetoric notwithstanding, it is wrong to say nothing has been achieved through negotiation with China. Only a few years ago, China’s current account surplus was the largest relative to GDP among significant countries, it was holding its currency down to maintain demand for its exports, and most software used on its personal computers and videos on sale in its major cities were pirated.

Today China’s global surpluses are far below past US negotiating targets of a few years ago, China has spent about $1tn propping up its currency, and IP protections are far better enforced than a few years ago for major US software and video producers. Of course major issues remain but the view that multilateral pressure without bluster is ineffective is belied by experience.

Third, extraction of IP through joint venture requirements is largely a problem for companies outsourcing production from the US and not for American workers. Corporations headquartered in the US often complain bitterly that if they wish to enter the Chinese market they must enter into joint ventures with Chinese counterparts who demand transfer of intellectual property and then operate on their own.

These complaints are often accurate. Notice, however, that they typically involve cases where the company in question produces for China in China and so have little impact on US employment. In many cases a substantial number of the company’s shareholders are foreign and it pays taxes to many governments. It is more than a little ironic that an administration that condemns outsourcing should make standing up for those who move production to China so central a priority.

Fourth, bilateral trade bluster is not an effective strategy for the US. While most countries feel somewhat threatened by Chinese trade and business practices, it has been the unfortunate accomplishment of US trade policy in recent months to cause most of the world to rally to China’s side because of our disregard for the WTO and the global system.

Not only does having many others on its side make it easier for China to resist the US, it also undercuts the effectiveness of our sanctions. China can still export to other markets and US producers who use Chinese inputs lose competitiveness when only they are forced to pay tariffs. History is clear that moments of high trade truculence like that pursued against Japan in the early 1990s accomplished very little while imposing substantial costs.

Fifth, threats have to be credible to be effective. In recent weeks, every time the US has pushed its strategy markets have had mini-collapses, and every time it has appeared to pull back markets have rallied. How in such a world can it seem credible that the US will actually carry through on its threats? And without credibility why should one expect strong responses from China? I return from a recent meeting with senior Chinese officials with the clear sense that they are more bemused than alarmed by what they see as a boomeranging US approach.

The US can do much better for itself and for the global economy but this is the subject for a subsequent column.

Implications of steel tariffs for the US economy

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In an interview on CNBC at the Asian Development Bank, Summers discussed the implications of steel tariffs for the US economy. The steel tariffs will do damage to the American economy “even before China retaliates” says Summers.

The Psychological Impact of Trade Sanctions

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In an interview with Bloomberg News on March 26, 2018 at the Asian Development Bank, Summers discussed the psychological impact of trade sanctions with China.

Tariffs raise concerns about future of US – China relations

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Is there any other way besides tariffs — and potentially a trade war — to get China to play fair on trade? David Greene interviews Summers for his insight on NPR’s Morning Edition.

Saving the heartland: Place-based policies in 21st Century America

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America’s regional disparities are large and regional convergence has declined if not disappeared. This wildly uneven economic landscape calls for a new look at spatially targeted policies. There are three plausible justifications for place-based policies–agglomeration economies, spatial equity and larger marginal returns to targeting social distress in high distress areas. The second justification is stronger than the first and the third justification is stronger than the second. The enormous social costs of non-employment suggests that fighting long-term joblessness is more important than fighting income inequality. Stronger tools, such as spatially targeted employment credits, may be needed in West Virginia than in San Francisco. Read the full paper here.

Brookings Papers on Economic Activity, Spring 2018

Benjamin Austin, Edward Glaeser, and Lawrence Summers 

 

Currency markets send a warning on the US economy

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One of the many surprising aspects of financial market performance over the past year has been the weak performance of the US dollar, which has fallen by close to 10 per cent on a trade weighted basis and by more than 10 per cent against the euro.
This has occurred despite a variety of factors that might have been expected to push the dollar up. They include upwards revisions in economic forecasts, expectation of monetary tightening, rising real and nominal long-term interest rates, fiscal stimulus on a huge scale in a full employment economy, rising protectionism that should choke off import flows, and tax reform directed at reducing capital outflows and increasing capital inflows.
It is instructive to consider what the combination of interest rates and current exchange rates says about market expectations of future currency values. US 10-year interest rates are about 230 basis points above German rates and about 280 basis points above Japanese rates. This implies that markets expect depreciation of the dollar by more than 25 per cent against its major competitors over the next decade. If dollar depreciation of this magnitude was not expected, investors would prefer dollar assets to foreign assets, given the interest rate differentials. Some but probably less than half of the dollar’s weakness can be explained by higher than expected inflation in the US. Real interest rates imply an expectation of continuing real depreciation.
Given the movements in interest rates in the past year along with the dollar’s fall it is reasonable to estimate that expectations of exchange rates of the dollar against the euro 10 years from now have fallen by perhaps 15 per cent. Information on real yields suggests that much of this move reflects expected declines in real exchange rates.
Exchange rates are relative prices and to understand dollar fluctuations one has to look at what has happened in the US as well as other countries. It is true that the improvements in the US economic outlook are smaller than those in Europe and in a number of other countries. To the extent that dollar weakness reflects disproportionate improvement abroad, it undercuts claims that US policy is the reason for recent strong performance since Donald Trump is not president of the whole world.
But this is only a partial explanation. If it were the dominant story one would expect to see rates in other countries rise more than in the US as they experienced larger increases in demand for investment funds. This has not for the most part happened. For example, both US real and nominal rates have risen relative to European rates. Put differently, expected forward exchange rates have declined more than current rates. The dollar’s weakness has also been pervasive against Canada and Mexico, which have not had growth surprises.
The pattern of higher interest rates and a weakening currency suggests that on multiple dimensions US assets now have to be put on sale at bargain prices to convince foreigners to hold them or induce Americans not to diversify into overseas assets. This pattern is relatively uncommon in the US though it happened in the Carter administration before Paul Volcker’s appointment as chair of the Federal Reserve and in the Clinton administration before Treasury secretary Robert Rubin’s invocation of the “strong dollar” policy. It is fairly ubiquitous in emerging markets where it reflects anxiety over a country’s policy framework.
I fear such anxiety may be emerging in the US. Mr Trump and Treasury secretary Steven Mnuchin show their ambivalence about a strong currency. Washington consciously takes budget deficits way up in a full-employment economy. Questions arise with respect to the Fed’s independence, America’s traditional receptivity to foreign investment and its willingness to lash out at holders of dollar assets.
These concerns are greatly magnified by the decision last week to impose across the board tariffs on steel and aluminium. The decision to invoke national security trade protections over the objection of the defense secretary raises questions about the coherence of policy processes. The fact that declines in the aggregate US stock markets were about 100 times as much as the gains for steel and aluminium companies illustrates that because the steel using sector dwarfs the steel producing sector, the net effect of the tariff policy is to reduce US competitiveness even before considering foreign retaliation. And then there is the risk that a president who likes trade wars will have more of them.
The confidence of global markets is much easier to maintain than to regain. Currency markets are sending a signal that the US is not on a healthy path. Its time for the US to strengthen the strong fundamentals on which a strong dollar and healthy economy depends.

No, “Obamasclerosis” wasnt a real problem for the economy

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The Wall Street Journal’s Greg Ip, reviewing the Trump administration’s first Council of Economic Advisers report, finds credible its claims that President Barack Obama’s policies, particularly in his second term, materially slowed economic growth, even though Ip acknowledges that the CEA’s assertions regarding magnitudes are likely exaggerated.

The CEA’s thesis is that a wave of tax and regulatory policies reduced both workers’ incentives to work and businesses’ incentives to invest, leading to slower economic growth than would otherwise have been achievable.

I am sympathetic to arguments of this type, having often observed that “business confidence is the cheapest form of stimulus.” And I would be the last to argue that every regulatory intervention of the late Obama years was salutary. I would also note that much of what the Obama administration proposed (for example, more infrastructure spending and responsible tax reform) would have triggered even greater economic growth but never came to pass, largely due to congressional roadblocks. There was certainly more that could have been done.

But at least three broad features of the economic landscape make the CEA’s view an unlikely explanation for disappointing economic growth.

First, the dominant reason for slow growth has been what economists label slow “total factor productivity” (TFP) growth. That is, the problem has not primarily been a shortage of capital and labor inputs into production, but rather slow growth in output, given inputs. After growing at about 1 ¾ percent per year between 1996 and 2004, the TFP growth rate has dropped by half since 2005.

While TFP has fallen off rapidly, there is no basis for supposing that levels of labor input or capital are less than one would expect given the magnitude of the Great Financial Crisis. In fact, labor force participation rates in 2016 lined up closely with Federal Reserve researchers’ 2006 predictions. This suggests the lack of importance of the various factors adduced by the CEA’s report.

Second, perhaps the biggest surprise of the last few years has been the remarkably low rate of inflation even as the unemployment rate has reached 4 percent. Year after year, consensus and Federal Reserve Board forecasts of inflation have fallen short of predictions. If, as the CEA believes, our slow economic growth is a result of too little supply of labor and capital, one would expect surprisingly high, rather than surprisingly low, inflation as demand growth collided with constricted supply. This is the opposite of what we observe. On the other hand, the secular stagnation hypothesis that emphasizes issues on the demand side would predict exactly the combination of sluggish growth, low inflation and low capital costs that we observe.

Third, the essential idea behind the CEA’s thesis is that capital has been greatly burdened in recent years by onerous regulation, high taxes and a lack of availability of labor. This idea is belied by the behavior of the stock market and of corporate profits. Over the course of Obama’s second term, corporate profits increased by nearly 20 percent, and the S&P 500 grew by more than 50 percent. This hardly suggests a period of excessively increasing burdens on capital.

The observation that share buybacks appear to be the largest use of the proceeds from the Trump tax cuts points in the same direction. Costs of capital have not been responsible for holding back investment in the United States in recent years.

If the “Obamasclerosis” theory does not fit the facts of slow growth in recent years, what are its likely causes? This will remain a matter for active research. But my guess is that key elements include hysteresis effects from the financial crisis and associated recession, reduced application of innovation in the economy in recent years, and possibly the adverse effects of rising monopoly power and diminishing competition in a range of markets.

Wells Fargo’s board members are getting off too easily

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A question I am asked as frequently as any other is: “Why didn’t anyone go to jail for the financial crisis?” There was huge suffering, sufficient misbehavior that the largest banks had to pay well over $100 billion in fines, and in the past, people had gone to jail for financial shenanigans during the Depression and the S&L crisis. People are usually indignant as they ask the question. Read more

Jerome Powell’s challenge at the Fed

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Janet L. Yellen has completed her term with unemployment much lower than it was when she began, with inflation low and closer to target, and with the financial system better capitalized and more liquid. What more can anyone ask from a Fed chair?

Yellen’s success is a tribute to her judgment and thoughtfulness. Importantly, though, like Alan Greenspan in the 1990s, she recognized quickly a major structural change in the economy and adjusted policy away from where traditional models would guide it. In Greenspan’s case, the structural change was the acceleration of productivity growth. In Yellen’s, it was the decline in the neutral rate of interest — the interest rate at which saving and investment would balance without either a major acceleration or deceleration in growth.

The fashionable view at the Federal Reserve and elsewhere when Yellen took office in 2014 was that growth was slow despite very low interest rates because of “headwinds” — transitory factors associated with the financial crisis that would soon recede. Without the headwinds, it would be possible for the economy to enjoy sustained growth with the “normal” 4 percent federal funds rate. On this view, the near-zero rate policy in place was highly expansionary and risked dangerous inflation.

By 2014, after five years of financial repair, the headwinds theory was losing credibility. Estimates of the neutral rate were starting to come in suggesting that it had been trending down for a long time. More straightforwardly, despite near-zero rates and the completion of financial repair as measured by credit spreads in 2009, growth remained slow. That is why I sought to resurrect the secular stagnation theory — the idea that the economy, except at moments of financial excess, was likely to suffer from an excess of saving over investment and be prone to sluggishness and insufficient inflation.

Without endorsing the idea of secular stagnation, Yellen led the Fed gradually but firmly to the recognition that the neutral rate had declined significantly, and to the corollary conclusion that policy was not as expansionary as generally supposed. Her instincts were corroborated and even proved to have been, if anything, too cautious as growth and inflation generally fell short of the Fed’s expectations during her tenure — even as interest rates were kept lower than expected and federal deficits increased more than expected.

It is fortunate for the U.S. economy that Yellen recognized changes in its structure and deviated from models and policy rules derived from historical experience. Had she followed such models, we quite likely would be in recession right now. Yet it must be acknowleged that growth in recent years associated with low interest rates would not have been as great as it was without the stock market increasing at a manifestly abnormal rate and without increases in borrowing that far outstripped growth in incomes.

Thus the first challenge facing the estimable Jerome H. Powell as Fed chairman is working out how to achieve growth that is both adequate and financially sustainable. Even with very low interest rates, the normal level of private saving consistently and substantially exceeds the normal level of private investment in the United States. And the differential is magnified by inflows of foreign capital. This creates a deflationary tendency that can be offset only by budget deficits or financial conditions that artificially depress saving and increase investment.

Asset values and levels of borrowing cannot indefinitely grow faster than gross domestic product, even though their ability to do so for a time has contributed to economic success over the past few years. If the Fed raises rates sufficiently to assure financial stability, there is the risk that the economy will slow too much. If it focuses on maintaining the growth necessary to meet its inflation target, there is the risk of further increases in leverage and asset prices setting the stage for trouble down the road.

There is a difficult balance to be struck. Except in the aftermath of recessions, it has been a long time since the U.S. economy grew well with a stable financial foundation. History will judge how stable the financial conditions of recent years have been. Prior to that, we were in recovery from the 2008-2009 recession. That in turn was preceded by a period of financial excess in housing and other markets. Prior to that came the 2001 recession and recovery, which in turn was preceded by the Internet and stock market bubbles of the late 1990s.

So it has been a generation since the U.S. economy enjoyed stable, financially sustainable growth from a position of strength. Good luck, Mr. Chairman.

In memoriam Bill McDonough

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William “Bill” McDonough was my friend. We met in January 1993 when I took up my new position leading international affairs at the Treasury Department, and Bill was preparing to become president of the New York Federal Reserve Bank. For the next eight years we probably spoke twice a week and much more frequently in times of crisis. I learned more from Bill than I was ever able to express to him.

In some ways, Bill was from central casting’s traditional idea of a central banker, and he acted the part. I never saw him in public and in doubt. In other ways, he was a very different from the typical central banker.

  • Most prefer to read a data table than a face. Not Bill. He knew how important relationships were when the chips were down and invested in them every day.
  • Most see the world in terms of global generalities. Bill cared about national particularities from native languages, to local rules, to culture. It made him a uniquely trusted figure, especially in Latin America but also around the world.
  • Most are stern and serious. I always picture Bill with a smile on his face as he explained to me what you had to grab to get hearts and minds to follow. He took what he did plenty seriously but he never took himself too seriously.
  • Most are pragmatists. Bill was too, but he was also a moralist. He knew that he lived a lucky life and he never forgot his good fortune. And he never let his friends forget that they too were, for the most part, highly fortunate and had obligations to those whose luck had been less good.

History alters perspectives. Some of Bill’s most important policy thrusts look more clearly right today than they did at the time. Bill was on to what we delicately call agency issues in finance before it was fashionable, as he warned about compensation practices. He was prescient on issues of systemic risk and capital adequacy. And his handling of Long-Term Capital Management, a hedge fund, presaged contemporary discussions of orderly workouts in important respects.

Gerry Corrigan had a worthy successor and Tim Geithner had a worthy predecessor in William McDonough.

I treasured Bill’s humor, wisdom and loyalty in equal measure. In those years of the Mexican financial crisis, the Asian financial crisis, a struggling Japan, and an ultimately defaulting Russia, Bill’s earthy, forceful warmth was a wonderful counterpart to the more abstract and analytical Greenspan in the conduct of financial diplomacy. Millions who never knew his name lived better more secure lives because of what he did.

May he rest in peace.

 

Why Treasury Secretaries should stick with the strong dollar mantra

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Yesterday in Davos, Secretary Mnuchin left the impression that he might be reversing 25 years of US Treasury strong dollar policy by asserting that, “Obviously a weaker dollar is good for us as it relates to trade and opportunities.”  The dollar then had its biggest one day decline in nearly a year and bond yields rose.  Commerce Secretary Ross later joined the fray claiming that the US strong dollar policy was unchanged but this did not affect markets. Read more

Trump’s big choice at Davos

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Will he reassure his audience that the US believes in strong global institutions?

Donald Trump will be attending this year’s World Economic Forum. Inevitably, attention will focus on whether the US president projects a commitment to internationalist values or reiterates his commitment to truculent nationalism in the name of making America “great again”. Attention will also focus on the question of the durability of the current economic and market upswing that has buoyed the spirits of businesses and investors around the world.

While President Trump will probably try to take credit for all the economic good news, it is unlikely that he deserves it. He is president of the US, not the whole world. And the economic surprises in the rest of the world have been more favourable than those in America. The scale of upwards revisions of growth forecasts for 2017 and 2018 is higher in Europe, Japan, China and emerging markets broadly than it is for the US. Many other stock markets have outperformed those in the US. If Mr Trump’s pro-business policies were driving the global economy, one would have expected an increase in net capital flows into the US, and so a stronger dollar. In fact, the dollar has weakened significantly in the last year, despite more Federal Reserve tightening than was anticipated at the beginning of 2017.

In the 1990s and again in 2006, I remarked that “the main thing we have to fear is lack of fear itself”. Today there is an undercurrent of geopolitical concern that was not present at those times. Yet there are important similarities between the situations then and now, where households and business come to fear missing out on good things more than getting caught up in irrational exuberance. Complacency about the economy can be a self-denying prophecy when it leads to excessive valuations, lending and spending. We are surely closer to such a point than we were a year ago. Sooner or later another downturn will come, perhaps because central banks overreact to what they perceive as inflationary threats, perhaps because elevated financial markets converge to more normal levels, or perhaps because of a geopolitical shock.

The world will have much less room than usual to manoeuvre if and when recession comes. From a narrow economic perspective there will be much less room than the usual 500 basis points of space to bring down rates. There will also be much less room for fiscal expansions than there was when countries were less indebted. At the political level, the kind of agreement forged in London in 2009 between the G20 group of most developed countries to keep markets open, support international institutions and co-operate to stimulate their economies seems much more difficult today. And there is the real risk in many countries that recession will reinforce tendencies towards authoritarian nationalist politics.

If the short run concern of those gathered in Davos is how the world will deal with the next recession when it comes, the long run one has to be the declining appeal of democratic global values. In countries as diverse as the US, UK, Turkey, Russia, Israel and China, it appears the governmental platform that commands the most popular support is rooted in nativism, nationalism and negativism. Populist nationalism eventually produces bad economic results, leading to more pressures for anti-establishment leadership and for extreme policies. It is far from obvious what re-equilibrates the system.

It is hard to predict whether the president will seek to reassure or provoke his audience in Davos. The president’s speech will most probably be compared with President Xi Jinping of China’s rousing defence of globalism at Davos last year. Mr Trump will be further challenged by the suspicion that his rhetoric cannot be relied on to be consistent from speech to speech, let alone to be consistent with subsequent action.

What should he say? It depends crucially on what he believes and that is far from clear. The world can accept a message that the US wants a fairer allocation of the burden of upholding the global system, that after a period of weak economic performance America needs to concentrate more efforts at home, and that it will be guided by its economic and security interests, and not the promotion of abstract values.

But such a message needs to be accompanied by clear signals that the US will strive to be a reliable and predictable partner, that it understands its interest in strong effective global institutions, and that it recognises that even self-interested nations can benefit from thoughtful diplomacy. If this is the combination of messages that comes out of Davos, a nervous world may become a bit less nervous. That would be a very good thing for those gathered at the forum — and everyone else as well.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary

If we want to improve global health, we need to start taxing the things that are killing us

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The world is going through a huge health transition, where the problems of the six billion people who live in emerging markets are increasingly the problems of the one billion people who live in rich countries. For the first time in history, more people suffer from eating too many calories than too few. Improving global health is no longer primarily about combating infectious diseases. Read more