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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