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( 12 mins)

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Washington, D.C.

Tuesday, December 1, 2020

Larry Summers

Let me make a few points. First, with respect to the global savings glut, Lucas Racial and I looked pretty carefully at that issue. Over the last 25 years, the current account deficit or surplus of the OECD countries has moved within only a 1% range. So, if you think about the real interest rate of the industrial world, there hasn’t been a change that was significant in the Ag and you think of that as an integrated economy. There hasn’t been a significant change in its current account surplus.

It is possible, I suppose, Olivier, that China could go into substantial current account deficit. But unless it did, what it did with respect to health insurance wouldn’t have bearing on the interest rates in the industrial world. I think it is hard to tell convincing stories about likely changes in emerging markets that are quantitatively large for the average real interest rate in industrial countries.

Second, the criteria that we proposed which emphasizes looking at the real interest burden associated with debt is precisely designed to allow for these contingencies. An approach that focuses fiscal policy on assuring that that doesn’t get too big is a criterion that will push fiscal policy to be stabilizing in the event that real interest rates were to rise significantly.

Third, there is a I think a fallacy that runs through much of this which is the assumption that interest rates are plausibly an important source of uncertainty for the level of deficits in debt in the future. If you think back to Jason’s chart highlighting that a confidence interval five or 10 years out is 10% wide for the level of deficits, suppose there was a 2% increase in the real interest rate which would be a very significant move. That is only a very small way through that confidence interval. The risks associated with phenomenal like secular stagnation protracted recession for the accumulation of debt are actually much greater than the risks associated with fluctuations in interest rates.

And I guess the last point I would want to highlight because I think it’s important to understand that the points of agreement and the ways in which we’re I think largely in agreement on what the fundamental problem is. Is that if Simpson-Bowles which everybody, virtually everyone was in agreement that having something like Simpson-Bowles and having the fiscal policy path that went with Simpson-Bowles would be a good thing.

Some people thought there was too much entitlement cuts, some people thought there were too much tax increases. There were a million arguments about the components. But there was no appreciable argument at the time about the goal. And if that goal had been achieved and if that goal had been maintained, the consequences would have been catastrophic.

Had we had a 4% of GDP fiscal contraction sustained for the half dozen years after 2011. Ben, I take your points about the efficacy of monetary policy. But I don’t think you’d want to argue that monetary policy would have been in any position at all to offset a consistent maintained 4% of GDP fiscal contraction in the years after 2011.

Yes, the economy was strong in the last couple of years but that had a lot to do with fiscal policy as well as with monetary policy. And, of course, in today’s world if fiscal policy stimulates demand, I believe that the level of income is a much more important determinate of investment and anything about interest rates once you’re starting in a world where interest rates are essentially zero.

The first thing to say is to just repeat what I said. Which is if we had done it the last time when there was a consensus that we should do it at the time of the Bowles-Simpson commission recommendations they would have been a grave error in terms of what their consequences would have been unless reverse. That’s, I think the first thing to keep in mind every time one hears that suggestion.

I think the second thing to say is that I think there are good reasons, not certain reasons, for believing that an economy with a positive neutral real interest rate is going to be a healthier, safer more productive and more financially stable economy than an economy with a negative normal real interest rate. And so, maintaining a posture of fiscal policy that permits a positive real interest rate is, I believe, in general the healthier strategy.

Then the only constraint, and I believe that the low real interest rate is also telling you something. The low real interest rate is a kind of measure of the risk adjusted productivity of capital. And when it’s zero, that’s telling you that in private investment that you crowd out is not a very costly kind of investment to crowd out.

So, then the question comes to the question of sustainability. And I think one should worry about sustainability. The question for countries with flexible exchange rates that do what I think we should do and this is a subpoint but I agree with Ken on the desirability of issuing debt with relatively long maturity. And as a consequence, I would much rather have my stimulus come from fiscal policy finance with long live debt then from monetary policy that takes the form of QE which reduces the horizon of the outstanding debt. Then it is a question of sustainability.

Ultimately while I am sympathetic to what Olivier said about the infinite horizon and such, I think the crucial point is does a nation like the United States have the capacity with its tax base? If it is absolutely imperative to do so, to mobilize an extra 2% or 3% of GDP and I find absurd the suggestion that it does not.

And therefore, I find the notion that there’s some risk of an inherent financial crisis to be highly implausible. So, I don’t worry that it’s going to be — that there’s a plausible scenario in which the ability of the nation to meet its debts is going to come into substantial question. And look, this experiment has been run. This experiment has been run.

The policies that Japan has run which are a very large version of the kind of more relaxed approach to fiscal policy that Jason is running, there would have been universal agreement 15 years ago. That if you ran the debt up to 200% of GDP, you would be in a grave situation. In fact, Japan’s got lower unemployment, has done very well in terms of per capita output relative to the rest of the world and the reasons have to do with the fact that they’ve been prepared to run very substantially expansionary fiscal policy.

And so, I think Japan stands as an example of the use of fiscal policy. Now should they have done things that were more efficient then a lot of the infrastructure they did, are Ken’s points right about infrastructure, yes. Those points are right and I would agree with them.

Could the interest rates change in 10 or 15 years, absolutely they could. But if you ask me about the risks in a world that 12 years ago had a huge financial crisis that this year has had a massive pandemic. If you ask me about the risks to the fiscal position of the United States, I don’t think that plausible fluctuations in real interest rates are an important part of them.

Olivier is absolutely right. That in 1985, I would not have forecasted a downwards trend that happened and that could happen again. But we need to maintain some robustness with respect to two standard deviation events. But that is very different from planning on the assumption of two standard deviation events.

So, I believe we should make our plans on the assumption that the economy would be catastrophically short of aggregate demand with zero interest rates and balanced budgets. Because that is what all the evidence is telling us right now and it may turn out to be different in the future. But we need to think about fiscal policy in the context of the idea that deficits are a necessity for achieving the goals of full employment and financial stability and quite possibly, very substantial deficits.

Just very quickly. I agree with Ken on everything he said about the micro economics of Japan. I was only addressing the macro economics of a fiscal policy strategy. And our calculations about interest rates all use February of 2020 before there was COVID. So, there’s seven years into a period of expansion.

Look there are all kinds of mistakes that are made going into crises. I think that among the most important things to do is to make sure that we don’t have a sustained period of slow growth. Which, I think, is a very substantial risk if we are providing insufficient impulse to aggregate demand. Which looking at the judgement of markets, looking at the current level of interest rates, strikes me as being the largest of the risks for the next several years though certainly not the only ones.

I’m sorry. What I intended to say and I may well have misspoken was we should devote — we should focus more on the mean than on the two-standard deviation outcome. But of course, as we focus on the mean, we should assure that we have a robust strategy for dealing with the two-standard deviation income.

Look, none of this is new. When Keynes came to the Treasury in 1942, he told everybody that the Social Security system was a terrific idea. Because it would replace private savings with Social Security entitlements and therefore maintain demand and therefore prevent a post-war depression.

And so, this idea which I’ve been saying in one way or another for a while that tax financed social insurance or tax financed redistribution will provide aggregate demand and that the correct conclusion is that you need to use the government budget in ways that will expand aggregate demand. Which is a different proposition then the proposition that the government needs to run a larger budget deficit.

One way, one most direct and obvious way of maintaining aggregate demand is through a larger budget deficit but it is by no means the only one. We could also be referencing use of credit guarantees in various ways. If we were in a world where costs of capital were higher, tax incentives for private investment would be something that we would be mentioning. In a current context, I don’t think they make much sense but support matching grant type support for public investment by state and local governments would be another use of fiscal policy to promote aggregate demand.

The main point here which I think we’re all agreed is that the maintenance of aggregate demand needs to be a crucial priority or fiscal policy if we’re going to absorb what’s likely to be a chronic excess, private savings over private investment.

So, I think it’s important to understand that if we do nothing, there will be Social Security reform in 2033 or whatever the year is, there will be across the board benefit cuts. So, our assumption was simply that we didn’t implement the reform of general revenue financing of current Social Security. We were careful to be talking about current law.

I don’t think there’s any case really for cutting benefits in the current context. I think there’s plenty of room to raise payroll tax ceilings in ways that would finance the maintenance of current benefits. And I think there are probably some other ways of strengthening the social insurance function of Social Security and those would-be things that I would support.

Whether this is the current political moment for those things, I’d leave that judgement to other people. But I think what I think is most important is that we have the paradigm shift to the view that having a fiscal policy that absorbs all the savings and maintains demand. And therefore, we get to points of full employment without having the kind of financial conditions that we had in 2007.

I think that is the central thing we need to understand and then you can work through exactly what the right things are. But the idea that our main problem is to save more in order to be more virtuous or to have less government borrowing in order to be more virtuous, I think what’s crucial is that we move beyond the sibilates.

Just to respond to your question. The central principle is that in a period of extraordinarily low interest rates that can be locked in for 10 to 30 years provides an unprecedented opportunity to address profound and longstanding investment deficits. Failing to take advantage of that opportunity is putting our children at risk and is putting our long term fiscal position at risk by weakening our potential for inclusive growth.

Low interest rates take advantage of the moment to address investment deficits exactly as Olivier said. Use as condition as one observes what’s happening and what’s happening to interest rates. The fraction of that investment that should be tax financed versus debt financed is a judgement that will need to be made on an ongoing basis.

But there is only the most negligible of probabilities that anything will happen in the next five years that will call into question the proposition that a careful, thoughtful, attentive to the details effort to remedy the investment deficits is what our economy requires right now.