LAWRENCE SUMMERS | Butler Award

Lawrence Summers accepts the Butler
Award from the New York Association
 for Business Economics, November 29.

On Friday, November 29, 2018 the New York Association for Business Economics NYABE) presented The William F. Butler Award to former Treasury Secretary Dr. Lawrence H. Summers, the President Emeritus of, and the Charles W. Eliot University Professor at, Harvard University. 

Summers has been close to the center of the economics profession for his entire professional career. He was a strong candidate for the position of Chairman of the Fed under Obama before the President settled on Janet Yellen.

My notes on the lunch talk, which is on the record to the press, at the Cornell Club in New York City, follow. This is not a transcript; I did not use a tape recorder. The portions in quotes were more carefully written down, but may not be verbatim. The unnumbered questions in bold face were from Alan Goldman, the current President of the NYABE, of which I was President in 2002-2003.

I am glad to receive an award from business economists. The best opinions on the current economic outlook come from the business economics community. “I do not believe there is anywhere you can go on this planet than to business economists to get a better take on the business cycle.”

What were your best calls as Secretary of the Treasury?

“I was quite good around the [2007-2009] fiscal crisis. I said what we fear most is the lack of fear among banks.”  “I said that banks were dangerously undercapitalized and needed an infusion of funds and a stimulus was in order.”

“I said declaration of victory over green sprouts in 2009 was massively premature.”

What were your worst calls?

Five years ago my call on China was not so good. It was premature.

I recommended in the 1990s that we help the Russians with their economy, using as an analogy the Marshall Plan. The Russian economy did not develop the way it did in Europe after WW2. My idea did not prove out.

In the mid-1990s and 2000s, I was wrong on my productivity projections.

The jury is still out on the secular stagnation theory for the US economy that I proposed in 2013 based on Alvin Hansen’s work. Structural changes raised the saving rate, lowered the investment propensity. I said we needed more investment incentives. I was accused of recommending an “imprudent fiscal policy.” The problem is we had a bubble at the end of the 1990s, then a recession after 2001, and then the Internet bubble. I felt we had to encourage more investment,

Since 2013, fiscal policy has indeed been more expansionary and the Fed has been easier than the market had previously expected. Growth was harder to obtain. We had bigger bubbles, but less growth. I called it secular stagnation, a change that lowered the long-term rate of unemployment.

Real interest rates in Japan and Europe were even lower than in the United States. Growth continues to be low by historical standards. This supports the secular stagnation theory. I am more sure of it today than in 2013. What are the prospects for a recession? Over the next two years, I would say 50 percent, but I wouldn't argue with 35 percent. I would wonder at anyone projecting a probability of either as low as 15 percent or as high as 90 percent. The problem is that the Fed putting interest rates down to zero again is not going to help.

If I were Chairman of the Fed today, I wouldn't take a position much different from Jay Powell, so far, i.e., tending toward dovish. But I would differ in three ways:

• I would focus on the 2 percent inflation target and I would observe that in the last ten years the Fed has always erred on the downside of this target. With only 3.7 percent unemployment, when if not now should we err on the upside?
• I would be sceptical of balance sheet manipulation. QE works only in the early stages or when it has signaling consequences. The cumulative impact of duration from debt offsets the QE. I would put less emphasis on balance sheet size.
• I would deemphasize the fetish for information provision and transparency. Stick with the "a strong dollar is in our national interest" mantra and deliver a consistent message, with less emphasis on disagreements within the FOMC.

Q1 (from the floor). What about the labor force participation rate? Americans are aging into retirement. More workers are more credibly facing competition from overseas, from robots [the Internet], from the gig economy.

Q2. Should the Fed go to negative interest rates? A negative rate is not likely to produce stimulus. They are "unworldly".

Q3. Could secular stagnation be overcome by innovation? I'm looking at demand, not supply side. I am agnostic about [Northwestern Professor] Bob Gordon's argument, which is supply side. 

Q4. What will Trump tax reform accomplish? The reforms have helped the well off, but is financed by deficits and is therefore contractionary. Damages our ability to invest in infrastructure. Traffic congestion is terrible in NYC; took me 40 minutes to go 1.5 miles.

Q5. Should bankers have gone to jail after 2008? Stupidity is not a crime. By containing the crisis [bailing out the banks] we have had less populism that we would otherwise have had. "There must have been crimes" is not a credible claim. However, bankers were allowed to just resign rather than being  made accountable. That was an error.

Q6. Are the tariffs and trade tensions slowing the world economy? Not so much that as the traditional cycle of fear and greed.

Q7. What topics in economics are not being studied enough? "Relative to its social importance, business economics is overemphasized." I would like to see more study of regional economics. What could public policy do, for example, in West Virginia? Also, structural questions need more study – creation of local infrastructure, development economics. This is insufficiently studied in the United States, in favor of financial topics.

Comment

Professor Summers is a careful and clear speaker; I am a long-hand and therefore selective note-taker. If I have misquoted or misinterpreted anything he said, please send a note to me at john [at] cityeconomist.com and I will look at it again.

In identifying his worst calls, Summers did not go back 19 years to his support of the 1999 Gramm-Leach-Bliley Act. This lifted some of the restrictions on banks' involvement in insurance and investment services that were imposed in the 1933 Glass-Steagall Act. Glass-Steagall was a brilliant deal, part of the New Deal, that traded commercial bank deposit insurance for regulations of banks and other financial institutions to keep "shadow banks" from playing with government-insured deposits. Critics of Summers for his support of Gramm-Leach-Bliley include former Presidents Bill Clinton and Barack Obama.

FOMC | Questions About Fed Models

Gov. Lael Brainard (top center) addressing the NYABE,
Cornell Club, NYC, May 30, 2017.

On Tuesday, Federal Reserve Board Governor Lael Brainard spoke to the New York Association for Business Economics. 

At the heart of the Federal Reserve System is the Federal Open Market Committee (FOMC), which since the days of Ralph Young in the 1950s and 1960s has, as its primary task, engaged in carrying out open market operations in Treasury bills to influence interest rates.

The idea behind FOMC intervention in the marketplace is that the Fed can fine-tune the economy, by buying Treasury bills to inject cash and lower short-term interest rates, or by selling Treasurys to remove cash and raise interest rates. 

Lower interest rates create "easy money" and that is supposed to encourage investment. However, the Fed has been at the "zero bound" in its interest-rate targeting since its statement of December 16, 2008. I wrote a piece for Huffington Post  on January 17, 2009, that quoted former Fed Vice-Chair Laurence Meyer. Speaking to the New York Association for Business Economics, Meyer said that the FOMC could go on vacation "for the next two years" until it lifted off from its zero-bound policy.

It's been more than eight years now and the Fed's interest-rate target is still below 1 percent. A quarter-point increase is expected at the next FOMC meeting in mid-June.

The worry about raising interest rates is that it will discourage investment, and also that in the absence of inflation it is not necessary. 

A full table of reporters in the back.
Bloomberg, Dow-Jones...

It is a time when basic questions are being asked about the implicit model on which FOMC model is based. Is it possible that the model-builders have lost touch with the data on which the models are based? Is inflation understated, for example?

After the lunch I asked Gov. Brainard what she thought about this. Her answers were helpful:

Marlin: "When I was working at the Federal Reserve Board more than fifty years ago..."
Brainard: "Fifty!?"
Marlin: "Fifty, under Chairman William McChesney Martin. The prevailing faith then was that higher [but moderate] inflation would encourage demand, and lower interest rates would stimulate investment. Is this still the faith?"
Brainard: "I think we are less confident now than we were then."
Marlin: "Is that because of a new theory, or less faith in the data?"
Brainard: "It's not because of change in the theory. It's more a question of alternative views about the econometrics, rather than the data."

The data and econometric issues are related, because models use high-level aggregate averages. For example, "inflation targeting" at 2 percent per annum is based on a few overall-average price levels. The expansion of the money supply during and after 1933 is given full credit by Christina Romer for the stimulus to the economy that ended the Great Depression.

But what if average-price components move in different directions and then one of them changes direction? As the economy changes, the time horizons over which averages are computed may also need to change. Here are some charts from the "Fed Dashboard" of how prices have been diverging.

Similarly, both the slow response of the economy to massive new debt creation since 2008 and the zero-bound interest target from January 2009 raise questions about the Keynesian narrative in changed financial markets. The markets responded as predicted when short-term interest rates were hiked, but lowering rates to the zero bound did not spur investment as expected.

If the theory on which FOMC policies are based hasn't changed, and interest-rate and inflation-targeting policies based on the theory have not achieved their goals, doesn't that imply problems with the models or the data?

Related Posts: FDR Nullifies Gold Contracts . Glass-Steagall . FDR's First Fireside Chat

FOMC | More Choices–Rip van Winkle Awakes

Oct. 29, 2014–What's the FOMC going to do today? A quick sampling of forecasts is that it will move away from QE3, its makeshift easy-money policy during the period of zero-bound interest rates.

I've been following the Fed since I worked there and at the FDIC five decades ago as a financial economist.

The latest week's Initial Unemployment Claims, which FRED (the wonderful database of the St. Louis Fed–thank you, James Bullard) graphs for us, has fallen to 283,000.

That's about to where it was briefly in 2000 before the dot-com bubble burst. Not since the early 1970s have initial claims been lower. This suggests inflation should be waiting to ambush us.

It's certainly taken a long time to get to this point. In January 2009, former Fed Governor and inflation hawk Laurence Meyer of Macroeconomic Advisers told a packed luncheon group sponsored by the New York Association for Business Economics that recovery was "at least 18 months away". He wasn't kidding.

Now, nearly six years later, we seem there. Unemployment is below the 6 percent threshold where the Fed historically (using the NAIRU) has started to worry about inflation.

However, wages have not kept pace, which shows slack in the labor market. And, as Paul Krugman reminds us, there are still no signs of overall inflation. (See graph - the Personal Consumption Expenditures chart shows the same pattern.)

So the Fed doves - Chair Janet Yellen, Gov. Daniel Tarullo, and Fed Bank Presidents William Dudley (NY), Charles Evans (Chicago) and Eric Rosengren (Boston) don't want to raise interest rates yet.

They point to the big mistake of FDR's economic policymaking in 1937, when interest rates were raised too soon. Wall Street has an adage: "When the Fed starts to crunch, it's time to go to lunch."

Fed hawks, however - Bank Presidents Richard Fisher (Dallas), Jeffrey Lacker (Richmond) and Charles Plosser (Philadelphia) - are concerned to stay ahead of the curve. They have their eyes on the 1970s when it seemed the Fed had lost control over prices because of the oil crisis... although former Fed Chair Paul Volcker proved in the early 1980s that if you closed your eyes to the temporary pain, the Fed can always dampen inflationary expectations.

At least in the coming months the FOMC will start getting back to the job it is familiar with, controlling T-bill interest rates through open market operations. A zero-bound interest context doesn't leave much latitude for policy options. Larry Meyer in 2009 even suggested, tongue in cheek, that  the FOMC take a long vacation. If they had followed his advice, they would just now be getting back to work. Like Washington Irving's Rip van Winkle, they may find it hard to settle back in to their traditional role after all these years.