Larry Summers provides the “full-proof” way to get back to the 2% inflation target

Matt O´Brien has a take:

It all starts with the Actual and Potential RGDP chart and the successive downgrades of potential RGDP growth by the CBO.

Full Proof_1

Larry Summers, who put this chart together, points out that the economy has needed lower and lower interest rates just to get enough investment to create jobs for everyone who wants one—until now, when it can’t push rates any lower. That means that, absent a bubble or stimulus, there might never be enough demand to keep us out of a quasi-recession, or worse.

Not only that, but this “secular stagnation” could turn deficient demand into deficient supply, too. It’s what economists call hysteresis, and the idea is that a long slump can hurt the economy’s productive capacity. That’s because the long-term unemployed could become unemployable, and too little investment today could create bottlenecks that prevent the economy from growing as much tomorrow.

This is what happened and is happening:

The Level Chart indicates that in 2008 monetary policy failed, bringing down the level of output (Y).

The Growth Chart indicates that from the new and lower real output level, the AD growth rate was brought down from about 5.5% to around 4%, with the result that RGDP growth is also lower. By keeping the economy stuck in the “Great Stagnation” (I prefer “Monotonic Depression”), the outcome could be a permanent leftward shift in the long run AS (as the CBO indicates in the first chart is already happening), which will have the effect of lowering real growth a bit more and increasing inflation back to 2%.

Full Proof_2

At that point you will hear central banks saying “job well done”!


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