It’s the demand, not the supply, stupid!
That’s what a former Clinton and Obama administration official, addressing a UBS conference, said was behind the economy’s four years of weak growth.
Larry Summers, former U.S. treasury secretary and director of the National Economic Council, called for more public and private spending. He also argued that fears about inflation and excessive government spending are unfounded.
“This is no time for austerity,” Summers said. The weak economy, whose growth rates have disappointed over the last four years, has “a shortage of demand instead of an excess of supply,” according to Summers, who was the featured speaker on Thursday at the UBS WM CIO Global Forum. Summers contended that the U.S. is in the grip of “a deficit hysteria” even though the debt-to-GDP ratio is projected to decline over the next decade.
Summers told the assembled advisors that the right fiscal and monetary policies for the U.S. will emphasize economic growth, not government spending cutbacks. He said increased public and private spending, including more public works projects, would restore confidence. Summers, in one of several times that he cited the 20th century economist John Maynard Keynes, said the nation is now caught in a “liquidity trap.” Individuals and business, with lots of cash on hand, are refusing to spend because they have lost confidence. He also cited Keynes’ paradox of thrift, which includes a warning that excessive saving can retard a recovery.
Summers, who also argued for relaxing the regulatory environment to promote growth, called for more money spent on airports, schools and improving cell phone networks. The U.S., he added, is falling behind the rest of the world in the latter.
“If you drive from Heathrow to London, the cell phones work all the way. If you drive from Beijing airport to Beijing, the cell phones work all the way. The same cannot be said for LaGuardia Airport, Logan Airport or Dulles Airport,” he said. Fixing cell phone networks is about private investment, he added. That requires “a more certain regulatory and policy environment, which would stimulate private investment. And that is hugely important.”
The essential problem with the economy, Summers insisted, is that “we live in a demand constrained economy—it is being constrained by demand, rather than limited by supply. That is the reflection of the particular liquidity trap we find ourselves in. And it means that many of the principles we have traditionally had in economics—the virtue of savings and balanced budgets and the like—have to be re-thought for the era we live in.” He also emphasized that it is important that the government find a way to raise stagnant wages.
Summers, who at one time was considered a candidate to replace Ben Bernanke as the next Federal Reserve Board chairman, praised the Obama administration’s stimulus policies in 2009. He said they saved the country from a depression that would have been greater than the depression of the 1920s and 1930s. He also predicted that the Congressional Republicans, in a couple of months, would not again try to use the threat of a government default as a way of pushing their agenda of budget cuts.
“They’re not going to shoot themselves in the foot again.”
Summers took a number of questions from advisors at the conference. Here are a few:
Even if you are correct that the debt-to-GDP ratio may decline in the next five years, it still remains fairly high by historical standards. So if there is a possibility that people don’t invest and don’t consume more because they feel poorer ... isn’t this an uncertainty that is keeping investment and consumption at bay?
Summers: I’m sure there are some issues of that kind. But I do not take they are likely to be of the high order judging where the American economy is right now for a few reasons. First, if people were expecting a lot of inflation, they might well spend before the inflation rather than not spend. And now they’re holding on to a lot of Treasuries at two or two and a half percent. That seems an odd thing to do if you thought there was a real risk that inflation was going to break out very soon.
Then you’d say, well, maybe people are expecting higher taxes. If the Chevys were selling well, but the Jaguars were selling poorly, that would a natural kind of pattern that would support what you say. In fact, the data all run the opposite way—toward spending at the high end being all robust and spending with people with $80,000 income being much less robust. It is sort of hard to believe that the reason they’re not spending is they’re thinking about some tax bill 10 or 20 years from now.
We are caught in a chicken-or-egg problem in which firms don’t hire because they don’t have the orders and consumers don’t spend because they don’t have the income. I think that simpler view is the way to understand the essence of the problem we have right now.
How can you say that austerity should not be exercised?
Summers: I think the essential points that I would emphasize are that there is a very big difference between an economy and a household. With the Summers household, it is certainly true that if we spend less we will save more. That means we will increase our wealth and decrease our debt. But the thing about an economy is that my spending equals your income. So when I spend less, you have less income. That also affects how much you can save. And that affects your situation.
This is what Keynes calls the “fallacy of composition.” The easiest illustration of it is everyone in this room can see reasonable well, but if a few of you eight rows back stood up, you could see even better. But if everyone stood up, then no one would see better. And just as one person standing up sees better, but everybody standing up cancels everybody out, everybody trying to save has that kind of effect in an economy. That’s why it is important for the government to do things to promote spending.