Monday , May 17 2021

Summers at FT

Martin Wolf's FT interview with Larry Summers is a great read. It would be a great read for its articulate numeracy if Larry were a Republican, stepping down from the Trump CEA or Treasury. That he is on the the other team makes it ever more poignant. If you look at the economy at the beginning ...

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Martin Wolf's FT interview with Larry Summers is a great read. It would be a great read for its articulate numeracy if Larry were a Republican, stepping down from the Trump CEA or Treasury. That he is on the the other team makes it ever more poignant. 

If you look at the economy at the beginning of this year, prevailing forecasts were that Covid would reduce wages and salaries to American households by $20bn-$30bn a month, with that figure declining over the year. So, that would be a $250bn-$300bn hole in wages and salaries over the course of the year.

So, I look at this hole and then I see $900bn of stimulus in the December package, $1.9tn of stimulus in the recently passed package and $2tn in the savings overhang, which is also likely to be spent. I see the Fed with its foot on the accelerator as hard as any Fed has ever done....

So, I look at that dwindling hole. Then I look at expenditures that aren’t hard to add into the multiple trillions, and I see substantial risk that the amount of water being poured in vastly exceeds the size of the bathtub.

Wait Larry, aren't you Mr. Secular Stagnation, Hysterisis, borrow and spend? 
How does this square with my earlier views on secular stagnation? I looked at the global economy and, indeed, at the US economy during the pre-Covid period and what I saw was that, at near-zero real interest rates, there was a quite substantial gap between private savings and investment, driven by demography, cheap capital goods, inequality and technology.
That substantial gap meant a deflationary tendency, one towards sluggishness and for savings to flow into existing assets and create asset bubbles. So, I felt that savings absorption was a central macroeconomic problem and the order of the problem was 3 or 4 per cent of GDP at very low interest rates that themselves carry substantial risks.
Now, when we’re talking about fiscal stimulus totalling 14 per cent of GDP in its first round, when we’re also talking about extraordinary monetary measures, structural effects of Covid — notably a large savings overhang — it seems to me that we are way overdoing the requisite response.
I always thought of economics as a quantitative field...

Not all of this makes sense to me. The stories of excess savings seem ephemeral, how savings vs. investment has anything to do with inflation -- a nominal question at the scale of decades -- and how any of that privileges "savings flow into existing assets and create asset bubbles" is a head-scratcher. 

Most of all, I am dubious of the hydraulic Keynesianism to which macro policy has returned. Find your GDP gap, divide by 1.5 (actually, here, divide by 1) that equals the amount to borrow and spread around. 

But I am here to praise not to quibble. At least hydraulic Keynesianism is quantitative, in a back of the envelope sense. Larry is pointing to the complete lack of quantification in macro policy otherwise. 


Let me put it in a different way and it’s sort of ironic. The bet that we can do this is a bet on secular stagnation being even more true than I had supposed. For this to be right, the long-term demand gap has to be far larger than I had imagined.

I don’t think that, until recently, the principal criticism of my views on secular stagnation was that I was very much underestimating its force. So I find it not a preponderant probability

In other words, MMT has won. I do chuckle a little at Summers and others, passed on the left by MMT, saying "no, we didn't mean that much stimulus, or that much slack." But Summers is and was quantitative,   he did not subscribe to the "how much? MORE" attitude of the current left. 

Of course, people in the Administration can also add. So the logical conclusion is that "stimulus" therefore is just a talking point, not a serious policy. They're taking Rahm Emmanuel's advice to heart and not letting the opportunity go to waste, not for macro benefit but to hand money out to where they want to hand money out. Larry essentially says as much. one was advocating a programme of this magnitude last December. This was not anyone’s economic analysis. So, the argument might be right — but it was not an argument anyone had come to before it became politically expedient.
On infrastructure (this is the last bill, not the current one, but I think Larry will probably say the same given how little actual infrastructure is in this one)  
I could have been comfortable with a headline figure well in excess of $1.9tn if it had been a large-scale, multiyear programme of public investment responding to our deepest societal concerns. But that’s not what this is.

It transfers to state and local governments that don’t have any new budget problem, according to the latest figures. It’s paying people, who have been unemployed, more in unemployment insurance than they earned when they were working. It’s giving cheques to families in the 90th percentile of income distribution.

It doesn’t seem prudent on resource allocation grounds, as well as being problematic on macroeconomic grounds.

Larry then goes back to the back of the stimulus envelope 

..there’s much discussion that suggests you can’t measure the GDP gap but, gosh, employment is 10m people lower than it might otherwise have been, so there’s got to be enormous slack.

As a rough calculation, if employment is 10m people short, that’s about 6 per cent of the labour force and, it appears, those who are not employed have wages of perhaps 60 per cent of the average worker. In terms of the shortfall in effective labour input, you’re at 60 per cent of 6 per cent, which is about 3.6 per cent.

So, in employment terms that gets you to just about the same gap that you come to in terms of more traditional estimates. You also don’t see the Fed or others substantially revising upwards their estimates of potential GDP.

There is a lot more on taxes, the possibility of closing the gap by taxing the rich,  and size of government I could quibble with, but leave that alone. Kudos to Larry for speaking out so forcefully when "his team" is headed in the wrong direction. 

A last golden paragraph: many ways, today’s situation is a bit like the 1960s. It was then hoped that the laws of economic arithmetic could be suspended and that it would all work out. That experiment didn’t work out well for Lyndon Johnson, economically, and it didn’t work out well for the Democratic party, politically. I think there is a significant risk that something of the same kind will happen today.

I hope Larry will next look at climate policy, which is suffering a similar lack of quantification. Has anyone seen a single cost-benefit analysis? [Update with important qualification, and thanks for the comment pointing I out: ...In the recent policy rush. Yes, the  literature is chock full of cost-benefit calculations, and it is exactly those that I miss. But from Keystone pipeline to the climate disclosure and ban fossil fuel movement at Fed and FSOC I have not seen any even referenced. I am happy to be shown to be wrong on this 

John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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