Larry Summers discusses the Great Stagnation

In “Larry Summers: Where Paul Krugman and I differ on secular stagnation” :

The topic of the debate was: “North America faces a Japan-style era of high unemployment and low growth.” Paul argued in favor. I opposed the motion — not on the grounds that the U.S. economy was in good shape, but on the grounds that our demand deficiency problems should be easier to solve than Japan’s…

And wraps up:

This is true and an important insight. But it seems to elide the main issue. Where is the deus ex machina? Where is the can opener? The essence of the secular stagnation and hysteresis ideas that I have been pushing is that there is no assurance that capitalist economies, when plunged into downturn, will, over any interval, revert to what had been normal. Understanding this phenomenon and responding to it seems the central challenge for macroeconomics in this era.

Any analysis that assumes restoration of previous equilibrium is, from this perspective, missing the main issue. I was glad to see Paul recognize this point recently.  I suspect it will lead to more emphasis on fiscal rather than monetary actions in depressed economies.

Summers is right about the relative seriousness of the Japanese demand deficiency problem. Japan´s monetary blunder was “criminal”, and the fiscal action that followed was nothing less than overwhelming (with countless bridges, some to nowhere, and even an airport over water). However, that did not help at all given the “dead in the water” monetary policy!

The two charts illustrate. The Japan NGDP trend is estimated for 1980-91, while the US trend is the Great Moderation trend established during 1987-97.

L Summers_GS




This bomb you´ll “never learn to love”

David Beckworth has a very good post: “The Origins of the Eurozone Monetary Policy Crisis”:

I made the case in my last post that the Eurozone crisis was largely a monetary policy crisis. That is, had the ECB lowered interest rates sooner and begun its QE program six years ago the fate of the Eurozone would be more certain. Instead, it raised interest rates in 2008 and 2011, waited until this year to begin QE, and allowed inflation expectations to drift down. In short, had the ECB been more Fed-like the Eurozone crisis would have been far milder.

This begs the question as to why the ECB failed to act more Fed-like. Why did it effectively keep monetary policy so tight for so long? 

For that question he provides a long answer. I´ll boil it down to two panels.

In panel 1 we have the behavior of NGDP relative to trend in 4 “core” countries (you may consider France “borderline”).


From this panel one could infer that the ECB (led by Trichet at the time) was setting policy in order to keep Germany, and only Germany, close to trend. When he increased rates in July 2008, Germany was the only core country above trend. In April and July 2011 Trichet raised rates again. Why? Because Germany, and only Germany, had climbed back to trend!

The negative effect of the 2011 rate rise was stronger in France than in the other core countries. France was on a “slow train” (compared to Germany) back to trend (green dashed trend line). Trichet, a Frenchman, threw France “off the train”!

You can imagine what the German-centric ECB actions did to the “periphery”. You don´t have to, just take a look at panel 2, that contemplates 4 peripheral countries:


Greece was “murdered”! Italy suffered with the 2001 rate rise. It was on the same “slow train” as France, but got ejected!

The amount of monetary tightening experienced in the “periphery” was an order of magnitude stronger than the tightening experienced by the core countries, and in Greece, it was about double the tightening experienced by its “peers”!

Bottom Line: “This is not a monetary union“. As is, the euro is unworkable.