Three paragraphs of Larry Summers

by on December 9, 2015 at 12:21 am in Economics | Permalink

A number of considerations make me doubt the US economy’s capacity to absorb significant increases in real rates over the next few years. First, they were trending down for 20 years before the crisis started and have continued that path since. Second, there is at least a significant risk that as the rest of the world struggles there will be substantial inflows of capital into the US leading to downward pressure on rates and upward pressure on the dollar, which in turn reduces demand for traded goods.

Third, the increases in demand achieved through low rates in recent years have come from pulling demand forward, resulting in lower levels of demand for the future. For example, lower rates have accelerated purchases of cars and other consumer durables and created apparent increases in wealth as asset prices inflate. In a sense, monetary easing has a narcotic aspect. To maintain a given level of stimulus requires continuing cuts in rates.

Fourth, profits are starting to turn down and regulatory pressure is inhibiting lending to small and medium sized businesses. Fifth, inflation mismeasurement may be growing as the share in the economy of items such as heathcare, where quality is hard to adjust for, grows. If so, apparent neutral real interest rates will decline even if there is no change in properly measured rates.

I already had read the FT piece, but Neil Irwin on Twitter directed my attention to the importance of those paragraphs in particular.  I do not always agree with Summers, but pondering his conundrums is never a mistake.

1 Thomas December 9, 2015 at 1:55 am

I can’t say “First” anymore or it will be censored.

2 TMC December 9, 2015 at 12:08 pm

And you’d look like an idiot.

3 Zach S December 9, 2015 at 2:30 am

“but pondering his conundrums is never a mistake” – to me, that is one of the most Tyler Cowen-esqe phrases I have seen on here in a while.

4 wwebd December 9, 2015 at 9:21 pm

Zach S – good point, but if I had been writing an imitation Tyler Cowen post I would have switched out “has never been, as far as I know” for “is”. By the way, I think of Summers as a very very good high-M low-V comedian. I was in my late 30s before the thought crossed my mind that, to understand the world in which I live, it might be desirable to be able to want to imagine what it would feel like to want to be the specific kind of “smartest guy in the room” Summers once described himself as being. (I guarantee you that the previous sentence is unprecedented on the internets, although it is a pretty good calque of the sort of banter one might have heard again and again from Math 550 “students” back in the day).

5 Bryan Willman December 9, 2015 at 2:34 am

Has any major economy raised its official interest rates in the last two years and been able to make that stick? (I don’t have a list but don’t recall reading of any such.)

What would make one believe that the US economy actually needs higher interest rates at a time when basically no other economy can use them?

6 JWatts December 9, 2015 at 10:36 am

I would imagine the collapse of the price of oil combined with Russian reliance on oil exports for hard currency makes Russia a special case.

7 JC December 9, 2015 at 3:16 am

“there is at least a significant risk that as the rest of the world struggles there will be substantial inflows of capital into the US leading to downward pressure on rates and upward pressure on the dollar”

Capital is flying from emerging markets already… BRICS are struggling, other emerging economies with big reliance on commodities are struggling, the “African Rising” story is about to end abruptly and capital control is the new rule across the continent…

8 Ignacio December 9, 2015 at 8:32 am

This is interesting. According to this, the lowering of the rates will not cause flows to be reduced into the US because investors are looking for a safe place for their funds, not returns. What should the US do with so much almost free money? If its economy is not large enough to absorb these funds efficiently, it should try to grow it.

When companies cannot grow organically, they acquire other companies. Maybe the US should try this. How about Puerto Rico becoming the 51st state? How about acquiring other territories? I am sure there would be countries interested in becoming part of the USA.***

*** This is obviously tongue-in-cheek

9 JC December 9, 2015 at 10:25 am

Maybe Putin is now inclined to place Crimea on he trading block…

10 mulp December 9, 2015 at 3:45 am

Damn regulatory pressure that prevents taking the savings of workers and shoveling them into failing small and medium size businesses where the savings will redistributed from the savers to the business’s suppliers by the unelected government technocrat called bankruptcy judge!

Why aren’t the rich capitalists buying shares of these businesses with their trillions in cash and expect only 1-2% returns which is higher than the US Treasuries they own instead?

11 Tom Warner December 9, 2015 at 6:04 am

“To maintain a given level of stimulus requires continuing cuts in rates.”

it’s surely true that fiscal stimulus is a policy-driven negative delta of the fiscal balance, regardless of the level: maintaining a traditionally large deficit is no stimulus. But I’m not sure how well that logic carries over to policy interest rates. There’s an inertia in the credit cycle that makes the duration of a low-policy-rate episode very important, I think.

12 rayward December 9, 2015 at 6:29 am

Summers’ observations about the past may be accurate, but is the past necessarily the future. By that I mean his first observation, that real rates have trended downward for the past 20 years, provides clues as to the present but does it provide a road map for the future. In economics as in life generally, there’s a predisposition to believe tomorrow will be just like today, only more so, leading to predictions about the future that are more often wrong than right. I would ask: why did real rates trend downward, and then make predictions about the future based on the present. My observation about most economists is that they come in two varieties: those who see history only as a straight line and those who ignore history by focusing on interesting but mostly irrelevant minutiae. As for Summers, his more recent work tries to make amends for his earlier work: one can learn from his mistakes or one can double down on them. I admire Summers because he has chosen to learn from his mistakes and chart a new path. What’s frustrating is that he often communicates in code, no doubt fearing that heterodox views in economics will be about as popular as heterodox views about a flat earth. To his credit, Cowen gets it: “I do not always agree with Summers, but pondering his conundrums is never a mistake.”

13 Gochujang December 9, 2015 at 8:43 am

He addresses the problem of fighting the global trend, that you create imbalances.

This idea that the Fed can just choose a rate is based on a false premise (textbook simplification?) of a single currency and economy, 1:1.

14 TomG December 9, 2015 at 6:44 am

>> regulatory pressure is inhibiting lending to small and medium sized businesses. <<

What are the details about lending to S&MEs? If the regulatory pressure is causing bankruptcy of the small business, that's pretty likely to be bad. If the regulations stops loans from going to a pre-bankrupt firm, that's likely good. If the at-risk SME would survive with a loan, but dies w/o the loan, the stopping of the loan, whether from regulatory or other reasons, is bad.
But none knows today, when the decision is being made, whether the loan will save the at-risk SME.

In general there is too much regulation, and a big reason for less growth despite low rates is the excess regulations new and small firms have to comply with.

15 stan December 9, 2015 at 12:37 pm

Small business startups have ground to halt. Community banks are being strangled. Long term healthy small businesses are being crushed under regulatory burdens.

The greatest stimulus to growth would be to stop the government monster.

16 Gochujang December 9, 2015 at 8:40 am

This is pretty close to what I have been thinking. I even mentioned that 20 year trend yesterday.

17 decimal December 9, 2015 at 9:10 am

#2 and #3 I get, but #1 doesn’t make sense to me. How does a historical trend inform what the interest rate should be set at today?

18 Gochujang December 9, 2015 at 9:22 am

My fuzzy thinking:

Let’s say you recognize that you have a global trade currency, a global reserve currency. You know that the business done in US dollars is larger than the business done on-shore and counted as GDP. You know reserves, money supply is held “in” foreign banks.

You know you are not alone. All other currencies work the same way.

Surely then the “flocking” we see of interest rates for major currencies in home central banks must emerge out of the system, rather than being set by any central bank alone.

Something in the system, some trend in the global economy, has pushed down global rates.

19 Gochujang December 9, 2015 at 9:28 am

People talk about targeting inflation or NGDP, they must recognize that any action is lossy, or creates feedbacks, because the action affects the domain of the currency, wider than the local inflation or GDP.

When central banks break from global trends, I think it is because they are in a bad spot, and are willing to risk those feedbacks, imbalances .. rightly or wrongly.

20 JWatts December 9, 2015 at 10:40 am

“#2 and #3 I get, but #1 doesn’t make sense to me. How does a historical trend inform what the interest rate should be set at today?”

Is he saying that the historical trend “set” the rate today, or that the historical trend indicates that there are many historical factors affecting the long term rate and that absence evidence to the contrary one should assume that those historical factors remain in effect?

21 Gochujang December 9, 2015 at 11:30 am

I would like to see alternate explanations for the 150 year chart, but I think the only thing that can produce that history is a slow turn (usually) of global factors.

The upward climb of 10 year bonds ran from 1940 to 1980. A long time. We have been on a downslope since 1980, another good long time.

Whatever happens, I expect another slow turn. Or I hope. You can see the countries that diverge with large and fast change. Never good.

22 chuck martel December 9, 2015 at 9:11 am

” increases in demand achieved through low rates in recent years have come from pulling demand forward, resulting in lower levels of demand for the future.”

That’s what a supposedly growing economy is all about, buy now pay later. With cars being financed for five years and more in an effort to boost current sales figures what does the future of auto manufacturing look like? GM is already moving production to China, where Buick sales are greater than in the US.

Economists deplore deflation because the mythology is that consumers will defer purchases in expectation of lower prices. Maybe a temporal leveling out of purchases would be better for the long-run economy than the boom followed by the inevitable bust.

23 WC Varones December 9, 2015 at 9:22 am

I’m with Larry.

Consumers and the government have record debt levels, which are sustainable only by ultra-low interest rates.

Significantly higher rates would be a bloodbath for consumers, asset prices, pensions, and government funding.

24 JWatts December 9, 2015 at 10:55 am

US consumers don’t have record levels of debt on a per capita basis.

https://research.stlouisfed.org/fred2/series/HDTGPDUSQ163N

Consumer debt has dropped significantly over the past 6 years. From 98% of GDP down to 80% of GDP.

25 Yancey Ward December 9, 2015 at 11:33 am

Yeah, but who owes on government debt? Who owes on corporate debt?

26 JWatts December 9, 2015 at 12:14 pm

Ultimately the consumer, but the payment mechanism and which sectors of society it impacts varies widely. It’s more useful to consider it discretely than just say everyone owes everything. US corporate debt and consumer debt look to be reasonably sustainable. US debt outside of SS and Medicare/Medicaid obligations is not sustainable. SS and Medicare/Medicaid obligations aren’t actually obligations per Court rulings, but most people aren’t aware of that and there liable to be treated as obligations to a great degree. As such, the US government does not have the means to keep them at the current level for more than about a decade without structural changes.

27 JWatts December 9, 2015 at 12:16 pm

Short version: Consumers/Corporation debt levels are OK, Federal, State and local government debt levels are in many cases not OK.

28 Bill December 9, 2015 at 5:08 pm

Which is why US government debt on 10 year bonds is 2%?

29 JWatts December 9, 2015 at 5:56 pm

“Which is why US government debt on 10 year bonds is 2%? ”

The price of 10 year bonds today does not indicate the price of 1 year notes in 2024.

30 Bill December 9, 2015 at 8:55 pm

JW, Did you ever learn what a discount rate is and why your statement would imply quite a discontinuity between the 11th and 20th year.

31 W.C. Varones December 9, 2015 at 3:37 pm

That’s total household debt, which declined largely due to foreclosures.

Consumer credit is all-time highs:

http://www.federalreserve.gov/releases/g19/current/

And existing mortgage debt is less of an issue for rising rates because much of it is fixed-rate for a number of years if not fixed-rate for 30.

32 W.C. Varones December 9, 2015 at 3:46 pm

And note that where mortgage debt declined due to foreclosures, it simply caused the exchange of a mortgage payment for a rent payment, so it only helps household cash flows to the extent that rental costs are less than ownership costs.

33 spencer December 9, 2015 at 9:38 am

In an open economy with a current account deficit the equilibrium or market clearing interest rate is the one that attracts sufficient foreign capital to finance the CA deficit with a stable currency.

If the currency is rising does it signal that rates are too high?

34 Gochujang December 9, 2015 at 9:54 am

In flocking behavior each bird has simple rules. Stay near other birds, not too near, not too far. The flock emerges from that. There need be no rule about who leads and who follows. There need be no rule about flock length, breadth, speed, or direction.

Your currency will be OK as long as you are in the flock?

35 spencer December 9, 2015 at 9:46 am

From 1976 to the early 200s the long run demand for cars and light trucks grew 0.7% annually.

Demand just surpassed that trend line this fall. So demand has been under trend for a decade.

Current auto and light truck sales are now the same as they were at the peak levels of the early 2000s.

Are you sure that demand for autos has been pulled forward?

36 Gochujang December 9, 2015 at 9:55 am

Complicated by increasing quality, vehicle lifespan.

37 JWatts December 9, 2015 at 10:59 am

Indeed. And not just the increase, but the slope of the increase.

38 Cooper December 9, 2015 at 1:09 pm

Also complicated by shifting demographic patterns.

1. A retired couple might only need 1 car while a working couple needs 2 cars.
2. Teenagers don’t have jobs and don’t need cars to drive to their non-existant job
3. Lower LFPR more generally means fewer commuters than normal.

Add those three trends together and you get a drop in demand for autos since the early 2000s.

39 collin December 9, 2015 at 10:58 am

Since the early 1970s, the average number of new cars has hardly moved from 15 to 16M per year. Today we are higher but that is probably because the huge fall in 2008 – 2010 although that backlog is probably ended. Several points. Cars are lasting a lot longer. If I remember right average life expectancy for a car was ~7 – 8 years and moved to 12 – 14 years today. I suspect this is effect a lot of goods and capital.

40 Brian Donohue December 9, 2015 at 10:44 am

The second point is interesting and may be decisive.

The rest is pretty thin, although there’s probably something to #5.

41 collin December 9, 2015 at 11:04 am

What if there is a new normal of lowering long term rates? Look at the Modern World:

1) The developed world has had a huge Baby Bust the last generation.
2) Capital investments are more productive.
3) The world is a lot safer. Outside of the Middle East, there is minimal war and military sucking up as much capital. (And all the PetroDollars are cycled back to weapon makers.)

42 Cooper December 9, 2015 at 1:03 pm

>>”Second, there is at least a significant risk that as the rest of the world struggles there will be substantial inflows of capital into the US leading to downward pressure on rates and upward pressure on the dollar, which in turn reduces demand for traded goods.”

So if we raise interest rates we strengthen the dollar and cause interest rates to fall?

Is that what he is saying?

43 Gochujang December 9, 2015 at 1:22 pm

What’s the opposite of a bond vigilante? There has to be a pithy name for global managers who throw money at yield, reducing it at auction.

Saw that Deutsche Bank thinks the US should raise its rates. Perhaps they have some money to push.

44 spencer December 9, 2015 at 2:56 pm

In the early 2000s auto and light truck sales bounced between 16 to 18 million.

From 2008 to 2014 auto and light truck sales ranged from 9 to 16 million and averaged 13.5 million. or even less than in the 1970s.

I repeat, exactly why do you think car sales have been pulled forward from the future?

45 spencer December 9, 2015 at 3:07 pm

From 1976 to 1980 — a recession year — auto sales averaged 13.5 million — exactly the same as from 2008 to 2014.

Since 1980 the number of licensed drivers in the US rose from 145,285,000 to 211,814,000 a 45% increase.

I repeat, exactly why do you think auto sales have been pulled forward from the future?

46 Kevin December 9, 2015 at 3:33 pm

“Fourth, profits are starting to turn down and regulatory pressure is inhibiting lending to small and medium sized businesses.”

Well let’s try to correct this.

It seems the political and financial classes have been quite uninterested in getting small and medium sized businesses grow or the regulatory burdens they’ve placed in the way of this – a consequence of which has been horrible job and age growth in the rcovery.

47 Dan Hanson December 9, 2015 at 5:00 pm

Here’s the scary part:

“Third, the increases in demand achieved through low rates in recent years have come from pulling demand forward, resulting in lower levels of demand for the future. ”

At least someone is willing to admit that price controls on capital are distorting the economy and the illusion of gain we’re seeing from this is in some respect the result of simply pulling demand forward, or robbing from the future. In other words, it’s going to be painful to get back to normal – so we shouldn’t endure the pain and instead just let the structural problem grow. What could go wrong?

Other reasons why raising interest rates is going to be difficult:

– The U.S. has a massive debt, with a large part of it financed with relatively short-term debt instruments. Raising interest rates will add tens or hundreds of billions of dollars to the deficit through increased interest payments.

– The Austrian argument that if a distortion is maintained for a long time, the economy will adapt to it. We’ve restructured our debts, changed our ratio of short-term to long term borrowing, our real estate market pricing is based on these artificially low rates, etc. This is unhealthy, but getting back to reality is going to result in some very painful shifts.

Of course, those of us arguing against government interventions like this pointed all this out at the time. Even Summers said that interventions had to be temporary and timely. Well, the ‘temporary’ interventions have been going on for 8 years now, and we are being thoroughly screwed by them.

The fact that billions of dollars in capital flows can change because Janet Yellin appeared to make a frowny face in a press conference is enough to tell you that this is really unhealthy behavior for a market economy.

48 jorod December 9, 2015 at 7:02 pm

The real problem is fiscal policy. Taxes keep going up, so does spending. Politicians find new reasons to give Social Security funds away to people for whom it was never intended. ‘Tax and spend’ is far from dead. Interest rates are a red herring.

49 Jeffrey Windham December 14, 2015 at 3:43 am

There is great room to criticize the linkage between low real interest rates, and the accelerated purchasing of cars and other consumer goods, citing that rapid consumption does not correlate with an increased quality of life, and that lower interest rates only tantalizes members of the middle class to agree to debt in exchange for a consumer good that may likely satisfy them for a shorter period of time than the loans duration. Personally I do not wish to become a slave to debt, and believe that individual quality of life is not dependent on one’s ability to consume. However, on a much larger scale one has to recognize that the incredible consumer machine that is the United States economy provides jobs. My own beliefs do not support the machine of consumerism the United States has become due to low interest rates propping up businesses to increase consumption, but I am more than happy to be a free rider taking advantage of the over consumption of others, and therefor welcome low interest rates more so because they support the system I intend to take advantage of, and not because they will make me feel more secure about buying a car I cannot afford.

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