Larry Summers has Concerns

Early this morning the Senate passed a budget resolution telling committees to spend an additional $ 1.9 T on Covid relief. Yesterday, Larry Summers wrote an op-ed expressing concerns about the imminent resolution. Like many many many people, I disagree in part. Oddly, I think I disagree less strongly with Summers than most US adults do.

Summers makes two arguments. The first is that the stimulus is too large

The proposed stimulus will total in the neighborhood of $150 billion a month, even before consideration of any follow-on measures. That is at least three times the size of the output shortfall.

Which implies a risk of overheating and undesirably high inflation

there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability. This will be manageable if monetary and fiscal policy can be rapidly adjusted to address the problem. But given the commitments the Fed has made, administration officials’ dismissal of even the possibility of inflation, and the difficulties in mobilizing congressional support for tax increases or spending cuts, there is the risk of inflation expectations rising sharply.

The second is that he argues that increased public spending is needed and the stimulus package will make it impossible

Second, long before covid-19, the U.S. economy faced fundamental problems of economic injustice, slow growth and inadequate public investment in everything from infrastructure to preschool education to renewable energy. These are at the heart of Biden’s emphasis on building back better.

If the stimulus proposal is enacted, Congress will have committed 15 percent of GDP with essentially no increase in public investment to address these challenges. After resolving the coronavirus crisis, how will political and economic space be found for the public investments that should be the nation’s highest priority?

I will discuss these in order, but first, I want to note that Summers does not make the common deficit hawk argument that the increased debt will be a burden on future generations. He doesn’t argue against this concern, he just ignores it. I agree that he is right to ignore the argument and not even mention it.

On the first concern (overheating) I note the main counterargument — the Fed can raise interest rates if the economy overheats. In contrast, it can’t cut short term safe interest rates which are at the zero lower bound. Summers mentions “commitments the Fed has made”. I am not sure what he has in mind, but I am sure that the Fed will not respect any such commitments if inflation rises well above the 2% target. The rest of the quoted passage rests on the assumption that monetary policy alone can’t bring output down to the non accelerating inflation level — hence the “and fiscal policy” after “monetary”. There is no reason to believe this — it is hard for those of us old enough to remember 1981-2 to even imagine someone believing this. I am sure Summers has another concern (remembering the 1980s) that loose fiscal and tight monetary policy will crowd out private investment (in practice mostly private investment in large new houses). I think this is the old capital formation obsessed Summers taking over from the new secular stagnation fearing Summers. But in any case, the argument makes no sense. It is known how to manage an risk of overhearting. There is a reason it hasn’t been a problem in the past 40 years.

The asymmetry in the effect of monetary policy due to the zero lower bound implies that fiscal policy should err on the side of stimulus. The fact that Krugman has written this again and again and again in the past 12 years doesn’t prevent it from being true.

Before going on, I have one of my usual pet peeves. When he discusses practical issues, like almost all macroeconomists, Summers assesses fiscal stimulus using the full employment deficit. This is based on the assumption that temporary tax cuts and cash transfers have the same effect on aggregate demand as government consumption plus investment. At the same time, macroeconomists who have some interest in DSGE models all of which have Ricardian equivalence (a set which includes neither Summers nor me) assume that temporary tax cuts and cash transfers have no effect on aggregate demand. This is impressive cognitive dissonance.

There are two arguments against the additional $1400 checks. One (Summers’s) is that there will be too much demand stimulus. The other is that the cash will just be saved, so it is inefficient demand stimulus. The arguments cancel. One does not have to believe that one off cash transfers will have no effect on demand to guess that the effect will be much smaller than, say, infrastructure spending. I find it odd that there is no standard guess based back of the envelope calculation somewhere in between assuming zero effect (as is very common) and assuming that cash transfers have the same effect as public spending.

I will discuss Summers’ second concern after the jump

OK so the second concern is about “political and economic space” for public investment. Again a lot of work is done by the “and”. There are two separate issues. The issue of economic space is a question about debt sustainability and the US Federal Government intertemporal budget constraint. The available economic space depends partly on the debt to GDP ratio but almost entirely on the difference between interest rates and GDP growth rates (oh one explanation: equally nominal interest minus nominal GDP growth or real interest minus real GDP growth — same difference). With 30 year real rates below zero, there is no reason to think the US Federal Government might be facing a binding intertemporal budget constraint.

Political space is outside of my field of specialty. I do not think that Democrats would gain political space by breaking a promise to voters. I don’t understand deficit panic and why it comes and goes. I notice however, that it doesn’t seem to have much of anything to do with the debt to GDP ratio.

I also am genuinely puzzled by “economic injustice, slow growth and inadequate public investment in everything from infrastructure to preschool education to renewable energy.” and “essentially no increase in public investment to address these challenges” .

First Summers seems to be thinking mostly of the $1400 checks and not the entire budget resolution. The resolution includes extended expanded unemployment insurance which will have a huge effect on inequality. It also includes an increase in fully refundable child credits. It is estimated that if approved they will cut the child poverty rate in half. These seem to be rather important efforts to address economic injustice. The resulution also includes funding for education and general aid to state and local governments. That is how US public education is mostly financed.

Second, he simply asserts that all of those challenges require public investment. Here again I see his old love of investment. For 35 years Summers has, off and on, argued that aggregate demand affects long run growth. Yesterday, is one of the off days in which he argues that long run growth depends on technology and invesment.

I think I can rephrase Summers’ second concern so that I agree with it. The $1400 checks will add to the public debt and we have no way of knowing whether a high debt to GDP ratio causes debt panic. Such panic would prevent public spending much more useful than mailing checks to the non-poor. The justification for $1400 for the employed is that they stimulate demand. This is not likely to be a problem and useful public investment also stimulates demand.

I might even be convinced that the checks are suboptimal policy. But, of course, they have invincible public support. There are also at least 51 Senators who will insist on phasing them out at lower incomes. I actually agree with those Senators, but, in any case, they will have their way.

I am going to conclude (in case anyone read this far) by noting that Summers’s op-ed is more balanced than one would guess given the critiques on the web (on Twitter mostly) and that his second concern makes a good deal of sense. Reading the op-ed, I was a bit surprised by the timing and had my points of disagreement (see above) but I am pretty sure that I am in the quarter of the US public which disagrees less with Summers.