Paul Krugman Hated Larry Summers for the Fed Chair. What Does He Think Now?

Larry Summers

Krugman still probably doesn't like Larry Summers for the Fed chair, likely for dispositional reasons.
Krugman might fear that Summers would end up pissing a lot of people off, and whether or not Summers got monetary policy right, he'd muck things up politically. Janey Yellen, on the other hand, has a defter touch, as Bernanke had, while being more dovish on the deficit than Ben was.

Whatever. From my distant vantage point, I might not have a clear view, but my gut says I'm right. It hardly matters on that score. Yellen is in -- and sure to be confirmed -- and Summers is out.

Yet this past week was a time in which Larry Summers not only said the right things in an important speech but, using slightly different language to get there, ended up largely supporting Paul Krugman's position on the liquidity trap. This delighted Krugman, though a little professional jealousy flared -- "Curse you, Larry Summers!" -- because Summers stated the case so well, so succinctly.

I watched the 16-minute speech with great interest. Summers seemed to be working without a written speech, likely with notes he rarely looked at. He had this stuff down cold.

The key phrase was "secular stagnation," which is hard for a non-economist to grok, but it might be better understood as "longer-term stagnation."

Paul Krugman

What worries Krugman and Summers is that we're in for a long period of stagnation with few options to get out of it without a bubble of some kind. That's the takeaway from Summers' speech, as well as an older blog post of Krugman's that clearly presages Summers' new points:

Our current episode of deleveraging will eventually end, which will shift the IS curve back to the right. But if we have effective financial regulation, as we should, it won’t shift all the way back to where it was before the crisis. Or to put it in plainer English, during the good old days demand was supported by an ever-growing burden of private debt, which we neither can nor should expect to resume; as a result, demand is going to be lower even once the crisis fades.

And here’s the worrisome thing: what if it turns out that we need ever-growing debt to stay out of a liquidity trap? What if the economy looks like Figure 4 even after deleveraging is over? Then what?

This is not a new fear: worries about secular stagnation, about a persistent shortfall of demand even at low interest rates, were very widespread just after World War II. At the time, those fears proved unfounded. But they weren’t irrational, and second time could be the charm.

Bear in mind that interest rates were actually pretty low even during the era of rising leverage, and got worryingly close to zero after the 2001 recession and even, you might say, after the 90-91 recession (there was talk of a liquidity trap even then). It’s not hard to believe that liquidity traps could become common, if not the norm, in an economy in which prudential action, public and private, has brought the era of rising leverage to an end.

And in that case, then what?

We might try to figure out why we seem to need leverage and bubbles to have full employment, and try to fix it. More thoughts on that on another day. But what if that isn’t an option?

One answer could be a higher inflation target, so that the real interest rate can go more negative. I’m for it! But you do have to wonder how effective that low real interest rate can be if we’re simultaneously limiting leverage.

Another answer could be sustained, deficit-financed fiscal stimulus. But, you say, this would lead to exploding public debt! Actually, no – not if the real interest rate is persistently below the economy’s growth rate, which it will certainly be if it’s persistently negative. In that case the government can run a primary deficit even while keeping the debt-GDP ratio constant – and the higher the level of debt, the higher the allowable deficit.

 Back to the more recent Krugman post on Summers' radical-but-right ideas:

Currently, even policymakers who are willing to concede that the liquidity trap makes nonsense of conventional notions of policy prudence are busy preparing for the time when normality returns. This means that they are preoccupied with the idea that they must act now to head off future crises. Yet this crisis isn’t over – and as Larry says, “Most of what would be done under the aegis of preventing a future crisis would be counterproductive.”

He goes on to say that the officially respectable policy agenda involves “doing less with monetary policy than was done before and doing less with fiscal policy than was done before,” even though the economy remains deeply depressed. And he says, a bit fuzzily but bravely all the same, that even improved financial regulation is not necessarily a good thing – that it may discourage irresponsible lending and borrowing at a time when more spending of any kind is good for the economy.

What seems obvious is that Krugman is drawing from Summers' remarks a new manifesto for looser fiscal policy: We're just not doing as much as we did in the beginning of the Great Depression. We're obsessed with the deficit trimming in 1937 that reignited the slump, just as the deficit obsession -- with our clumsy sequestration, government shutdowns, and debt-ceiling repeat debacles -- has stifled all opportunities to grow our economy without requiring new bubbles. What's next, another stock-market bubble caused by QE? That's already happening, but it's doing nothing for middle-class consumption. So it's not very bubblicious and won't do much for longer-term real economic growth. Also, it's not clear how and when we responsibly back out of it, or "taper."

What's left? I know my favorite responses to today's apparent secular stagnation: large fiscal stimulus programs in building infrastructure, greater education spending, radically raising the minimum wage to $15 an hour, higher taxes on the rich to pay for expanding Social Security and Medicare (for all!), and a guaranteed income paid by, for example, a carbon-footprint tax: the more carbon you use, the higher your taxes, the less you use, the potential for a substantial tax credit, which is certainly one way to provide a minimum income while likely spurring energy innovation, which in turn would stimulate the economy. It could help fight global warming, as well.

Yes, solve income inequality through income redistribution. If that's radical, let's get radical. After all, Paul Krugman has been calling for it, and now Larry Summers is getting on the bandwagon. I read his remarks as calling for a return to Keynesian principles. With a bubble economy -- without a bubble in sight -- we may have no choice.

More than four years after the end of the recession, still not enough jobs? Not good.