Lawrence Summers is a professor and past president at Harvard. He was Treasury secretary from 1999 to 2001 and economic adviser to President Obama from 2009 through 2010.
The world’s finance ministers and central bank governors will gather in Washington this week for the twice-yearly meetings of the International Monetary Fund. While there will certainly not be the sense of alarm that dominated these meetings for a number of years after the financial crisis, the unfortunate reality is that the medium-term prospects for the global economy have not been so problematic for a long time.
In its current World Economic Outlook, the IMF essentially endorses the secular stagnation hypothesis — noting that the real interest rate necessary to bring about enough demand for full employment has declined significantly and is likely to remain depressed for a substantial period. Without robust growth in industrial world markets, growth in emerging economies is likely to subside even without considering the political challenges facing countries as diverse as Brazil, China, South Africa, Russia and Turkey.
In the face of inadequate demand, the world’s primary strategy is easy money. Base interest rates remain at essentially floor levels throughout most of the industrial world. While the United States is tapering quantitative easing, Japan continues to ease on a large scale and Europe seems to be moving closer to taking such a step. All this is better than the kind of tight money that in the 1930s made the Depression great. But it is highly problematic as a dominant growth strategy.
We do not have a strong basis for supposing that reductions in interest rates from very low levels have a large impact on spending decisions. We do know that they strongly encourage leverage, that they place pressure on return-seeking investors to take increased risk, that they inflate asset values and reward financial activity. The spending they induce tends to come at the expense of future demand. We cannot confidently predict the ultimate impacts of the unwinding of massive central bank balance sheets on markets or on the confidence of investors. Finally, a strategy of indefinitely sustained easy money leaves central banks dangerously short of response capacity when and if the next recession comes.
A proper growth strategy would recognize that an era of low real interest rates presents opportunities as well as risks and would focus on the promotion of high-return investments. It would have a number of elements.
In the United States, the case for substantial investment promotion is overwhelming. Increased infrastructure spending, for example, would in all likelihood reduce burdens on future generations not just by spurring growth, but by expanding the economy’s capacity and reducing deferred maintenance costs. Take the United States’ air traffic control system: Can it possibly be rational in the 21st century to rely on vacuum tubes and paper tracking of flight paths? Equally important, government could do much at no cost to promote private investment, including authorizing oil and natural gas exports, bringing clarity to the future of corporate taxes and moving forward on international trade agreements.
With the increase of the value added tax on April 1, Japan is now engaged in a major fiscal contraction at a time when it is far from clear whether last year’s progress in reversing deflation is anything more than a reflection of one-off exchange rate movements. A return to stagnation and deflation could rapidly call its solvency into question. Japan takes a dangerous risk if it waits to observe the consequences before enacting new fiscal and structural reform measures to promote spending.
Europe has moved back from the brink, with defaults or devaluations now remote possibilities. But no strategy for durable growth is yet in place and the slide toward deflation continues. Strong actions to restore the banking system to the point at which it can be a conduit for a robust flow of credit are imperative, as are measures to promote demand in the countries with more depressed economies.
If emerging markets’ capital inflows fall off substantially, moving them further toward being net exporters, it is hard to see what markets can take up the slack. So reform measures to bolster capital flows and exports to emerging markets are essential. These include, most important, political steps to reassure investors about populist threats in a number of countries and provide investor protection and backstop finance. In this regard, passage by the Congress of authorization for IMF reform is imperative. Also, creative consideration should be given to ways of mobilizing the trillions of dollars in public assets now held by central banks and sovereign wealth funds to promote growth.
In an interdependent global economy, the impact of these measures together is likely to be substantially greater than the sum of their individual impacts. And the consequences of national policy failures are likely to cascade. That is why a global growth strategy framed to resist secular stagnation rather than simply to muddle through with the palliative of easy money should be this week’s agenda.