Summary: A weakness of my posts is that they don’t adequately convey the wonders of our time, the extraordinary events, the uncertainty of future outcomes. Today I attempt to show the amazing nature of our new economy, as highlighted in last weeks’ speech by Larry Summers. We have entered a new world, for ill or better.
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Olivier Blanchard is Director of Research at the IMF and a Professor of Economics at MIT. He goes to the heart of our situation in this title: “Monetary Policy Will Never Be the Same“, 19 November 2013 — “In short, monetary policy will never be the same after the crisis. The {IMF Economic Forum} helped us understand how it had moved, and where we have to focus our research and policy efforts in the future.”
We should listen to Blanchard. The response of the major nations to the crisis took us into a new world. Step by step monetary policies have grown bigger and stronger (in several dimensions), beyond anything previously seen in peacetime There are few signs of the world returning to normal soon.
But Blanchard’s statement is true in another way. Larry Summers’ speech opens a new perspective on our situation. The conventional view of the US is an economy in an unusually long but very slow expansion, responding to intense fiscal and monetary stimulus. Summers instead suggests that the US has fallen into the same hole as Japan did in 1989. Perhaps the entire developed world has.
More specifically, we might be in a world of secular stagnation. That the real return on capital might have dropped to zero — or gone negative. As Japan has shown, in this hole even low levels of real interest rates fail to spur investment. Monetary stimulus only blows bubbles. This condition can continue for years, until the real return on capital returns to more normal levels.
The standard Keynesian solution is — as I and so many others have advocated for so long — fiscal stimulus. Borrow at low rates to rebuild our decaying infrastructure, and do other things with a positive return to society. This helps to return the economy more quickly to a good equilibrium. It would channel the excess liquidity created by monetary stimulus into the real world, instead of boosting asset prices.
The obvious solution remains unlikely due to dysfunctional political systems in the US and Europe (it’s being used in Japan, but a corrupt political establishment is in effect burning the money).
Conclusion
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“Unless you expect the unexpected you will never find truth, for it is difficult to discover.”
— Heraclitus, the pre-Socratic “Weeping Philosopher” of Ionia
Summers’ insight, and the surge of analysis it has sparked, takes us into a new chapter of what is already an amazing story. It explains many odd and discordant aspects of the economy and markets since the crash.
His insight has broader implications. Step by step we move into a new world. Journalists report the minutia of each step so that we get lost in details, creating an illusion of normality. As always, memory of the past provides an anchor for our understanding and benchmark by which to evaluate past forecasts.
How does this end? We have moved to the frontier of economic theory, where it can (barely) explain current events, but not reliably predict the next chapter — let alone the timing or nature of this cycle’s conclusion. I wonder if the future even lies among the known scenarios of experts.
I believe that we live in the tails of probability distributions, with outcomes we experience mostly unlikely. But that’s just a guess. Perhaps the passing years will return us to the old days.
Hopefully for some of you these posts help place these events in their historical context. In conclusion, I give you this advice. Regard the confident forecasts of experts with appropriate skepticism. Cherish the surprise of each development! Stay nimble; avoid becoming rooted in your preconceptions.
Previous posts in this series
- Are we following Japan into an era of slow growth, even stagnation?, 18 November 2013
- Larry Summers gives us the bad news. Worse, the only solution is more of the same., 20 November 2013
For More Information
Previous posts in this series gave links to posts about Japan, and about monetary policy. Here are links to posts about growth.
- Good news: The Singularity is coming (again), 8 December 2007
- The Singularity is in our past, 29 March 2009
- Has America grown old, and can no longer grow? Or are wonders like the singularity in our future?, 28 August 2012
- Is America on the road to zero growth?, 29 November 2012
- Why America’s growth is slowing, and a solution, 28 January 2013
- Will 21st Century USA have a surprise boom, as did the 19th Century UK?, 23 October 2013
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“The obvious solution remains unlikely due to dysfunctional political systems in the US and Europe”
At what point does the sane response of central bankers become to say, loudly and publicly, to their governments, “You have left us with a hammer to pound in a screw. We are stopping now, before we break something. The tools for this job are in your hands, not ours. Use them!”?
Part of addressing dysfunction is to stop covering for it.
That depends on whom the central bankers serve. Things will not change if they serve the 1% as the current situation is massively increasing their wealth. Janet Yellen has indicated a willingness to continue the current QE program for quite some time and perhaps expand it.
At some point in the distant future (3-7 years? 25 years? 50 years?) there will be consequences for these actions but I cannot say what they will be. I can only say that the consequences will come when the average investor perceives that the central bankers are unable/unwilling to cover losses incurred by the investor. On that day our world will change again.
Pluto goes to a central truth. By design the US a Central Bank responds first to the bankers, and has since the First and Second National Banks, which is why they were killed.
Now bankers are more powerful, and the rise of the Fed both demonstrates this and executes it.
I agree that fiscal stimulus is needed.
However, it appears that the government will not do so.
In which event, either there will be no stimulus or it will have to come from elsewhere.
The challenge of our times is to seek non-governmental means of stimulus.
“The challenge of our times is to seek non-governmental means of stimulus.”
… or to fix the government.
Really, though, I think stimulus is almost certainly too narrow a focus. For the immediate situation, it would surely help. But the question Larry Summers’ observations should raise is: Why do we need stimulus, or negative real interest rates, or asset bubbles… something, always, to goose up our economy lest it stall? The challenge of our times is to answer that question, and then do something about it.a
“The challenge of our times is to seek non-governmental means of stimulus.”
What did you mean by this, Duncan? With the Federal Government becoming ever more parsimonious, and the big banks apparently content to trade paper assets around a circle that resembles some combination of a Tammany Ring and a game of Chinese Whispers, this doesn’t leave a lot of options for enterprising entrepreneurs to stimulate with much effectiveness.
In my line of work (real estate), the largely illiquid financing environment has led many local projects to seek foreign investment, especially Chinese investment. While this does often help to finance local infrastructure improvements that might have otherwise had to rely on increasingly unavailable Federal funding, it’s also very tricky both legally and logistically, and I feel hardly the optimal means of stimulus.
What other options are there? Maybe some sort of infrastructure bank co-operative fund?
Todd,
“The challenge of our times is to seek non-governmental means of stimulus.”
The challenge of our time is to overcome those who seek to weaken us by blocking our ability to build America through government investment.
Among other consequence is this, our infrastructure is rotting away.
Todd:
I really wish I had a good answer to your question. Right now, you may fairly compare me to Don Quixote.
Right now, actually, running through the back of my mind is a refrain from an old song: “We built this city on rock and roll.” And – if we are to make progress – we need entirely to abandon conventional frameworks and – instead – take propositions like that seriously.
Have we already entered an economic singularity? What is on the other side? Almost seems like what Summers is suggesting.
Doug,
Why do you say that? A singularity is a point where the rules break down. Not so today, as demographic change and technological slowing combine to lower the rate of growth.
It seems like some of the rules are breaking down, as indicated in Summer’s remarks.
What worked in the past may no longer work in the future. But then the rules may not be complete.
If we have a “New Economy”, does it have new rules? Or perhaps the rules are constantly changing?
I have often thought that might be the reality, just from observing the markets.
Doug,
Summers says that growth rates are slowing, depressing the rate of return on capital and the natural rate of interest. This does change the rules.
It means that we move to conditions where the usual policy tools do not work. Think of changing the inside temperature of your house from 90*F to zero. Lots of normal tools will not work.
Modern economies are recent inventions, as history goes. Much like climate. What we consider “normal” is just one of many likely states.
Do we know how things work in a negative real interest rate environment?
Do we know that the rules going forward will be the same as the rules that worked in the past?
As the system adapts to the “New Normal”, might the rules also adapt? Might behaviors change in ways we could not predict based on previous experience?
Doug,
(1) Economists, as scientists, work to discover physical laws — unchanging relationships in the physical world. I don’t know what you mean by “rules”, which I see as normative statements — such as the laws passed by Congress. I think that’s what is confusing you.
(2) “Do we know how things work in a negative real interest rate environment?”
That is an important point of Summers, developed more by economists responding to him.
(a) Changes of scale does not change physical laws, but changes how they play out. Ants live in a different world than as ours. Surface tension and friction are often larger than gravity to them.
(b) The known economic laws might be a subset of the actual laws, much like Newton’s Laws are a narrower condition of those that include relativistic speeds. A world with negative equilibrium interest rates might work differently than the post-WW2 world.
(3) “Do we know that the rules going forward will be the same as the rules that worked in the past?”
Yes, the true laws always apply. That is something we know. Or rather assume; breaking that assumption would be a revolution of unimaginable scale.
Fabius,
I understand what you are saying, but I think the notion that the behavior of living organism or group of such organisms, follows some immutable rules may be flawed. It dismisses the ability to learn and adapt. Yes there are some physical limits imposed by physics and chemistry, but I suspect behavior in response to stimuli may evolve as a learning process, and is not subject to any laws, rules or truths.
I do not believe that economists work to discover physical laws. I believe they study one particular aspect of human behavior. One of the unique characteristics of those subjects being observed by the economists is that they are also observing and learning from the same observations that are being made by these “experts”. This learning should result in some modification of behavior by these subjects. Thus the “laws” discovered by the expert economists can become obsolete.
Doug,
I suspect you have little familiarity with what economists actually do.
IS-LM Graphs, supply and demand curves, discounting rules, Pareto efficiency, Ricardo’s theory of trade — none of these fit your description.
– “a world of secular stagnation”
I wonder to what extent there is a connection with the ageing populations in the rich countries.
The effects on demand and need for investment both in infrastructure but also commercial investments could be considerable. If demand and investment needs are on a path of steady decline due to demography can these problems even be solved by other means than another crisis.
In a couple recent posts (1, 2), Fabius Maximus wrote:
I thought you were exaggerating, to contrast with your organic (addiction) analogy… and then, after Larry Summers’ speech and the discussions that followed, I see this:
Is it really beyond the scope of mainstream macroeconomics to suspect that maybe, if monetary policy appears simultaneously too loose and too tight, it’s not that either side is wrong, but that there is something dysfunctional in the system that cannot be repaired with monetary policy?
Coises,
“if monetary policy appears simultaneously too loose and too tight”
That would be odd, but it’s not what Krugman et al are saying.
This describes a condition in which monetary policy stimulus should run at a high level to maintain acceptable activity in the real economy. As a side effect this will induce asset price bubbles. The debate among economists concerns the net effects of such a policy, and its desirability.
An example of a mechanical economic model is belief that QE provides little stimulus to the economy, and therefore reversing QE will produce no significant effects.
“The standard Keynesian solution is — as I and so many others have advocated for so long — fiscal stimulus.”
FM, it took you 5 years to find the courage to say this.
What do you have to teach those that were saying it 5 years ago?
What do you have to teach those that saw it comming in 1981? when shift that lead to this outcome was happening?
What do you have to teach those that saw this comming in 1990? in 2000, in 2010?
You guys fought against such predictions with tooth and nail and now you are trying to teach again?
How long it took you guys to see this when many were seing it before you and now you are finaly discovering your own epiphany and thinking that nobody knew that before you yourself saw it.
Truth is, you guys are still far behind others who knew about this solution long before you found out.
You still have to discover why it came to this, what model leads to this outcome, what lies behind all this. why it led to this in a process that took 40 years to this outcome. You are far behind us who knew this long time ago. And you still can not see this process that lasted 40 years, you still refuse to accept that it is such long term process.
Jordan,
“FM, it took you 5 years to find the courage to say this. What do you have to teach those that were saying it 5 years ago?
As usual, you are totally wrong. I await your apology.
I recommended large-scale fiscal stimulus almost exactly five years ago on 28 November 2008:
The US Economy Must Go to DEFCON One
http://fabiusmaximus.com/2008/11/13/defcon-1/
And I have repeated that in dozens of posts since:
http://fabiusmaximus.com/tag/fiscal-policy/
I lifted your moderation in the holiday spirit. I will have the Grinch restart it with more nonsense like this.
I admit my mistake and i give you my appology.
I am mistaken since so many times i read warnings about US debt. It must have been other FM while you probaly never wrote nothing against US debt.
And to say that i follow this blog a bit more then a year so was not aware about those posts.
But, again i appologize.
But i will found myself confused whenever i read some warnings about public debt, if that ever happens again.
Jordan,
“I am mistaken since so many times i read warnings about US debt. It must have been other FM while you probaly never wrote nothing against US debt.”
I consistently have said that debt is poisonous if not spent on something that gives an economic or social return.
We have run up massive debts since the crash with little return (note that income stabilization is immediately valuable, the equivalent of fire-fighting). Our foreign wars and nearly-useless weapons (e.g., the F-35 debacle) are prime examples. This money is gone like last winter’s snow.
That you have read all this — in scores of posts, many in the past year — and failed to grasp my simple point is obtuse beyond imagining. That you write this snarky nonsense soon after I explained it — with links — is worse.
I gave warnings. I did a period of moderated comments, then lifted it. Now I am banning you. Three strikes. Life is too short to waste it reading this.
Further details about ” income stabilization”
AKA the safety net. And it is justifiable on moral as well as economic grounds.
fiscal stimulus is over-rated, visit china’s ghost cities and mega-malls and ghost airports to see the wonder of fiscal stimulus.
Morse,
That is quite a daft comment.
China is not applying fiscal stimulus in the usual sense. China runs small budget deficits, quite appropriate for a rapidly growing emerging nation still building its basic infrastructure.
Nor is it clear that they have over-built their infrastructure. Third world nations are plagued by cancerous ring slums around their cities, as migrants from rural areas find no place to live. China has handled their internal migration quite well, building new cities for hundreds of millions of migrants.
This is an extraordinary achievement. Getting it wrong in a few places (the stories almost all describe the same one, Ordos) is a trivial detail in a nation of 1.4 billion people.
This is the equivalent of pointing to the many failed tech companies in the US during the past 15 years and declaring the tech industry a bust.