In weighing the possible appointment of Larry Summers to be chairman of the Federal Reserve, analysts have found his views on what would be his main job in that role —setting U.S. monetary policy — to be hard to parse. Summers has weighed in only vaguely and rarely on the subject. And those digging for more information have even gone back to things that Summers said in 1991 to try to project his current views!
But less attention has been paid to Summers's comments last spring at an event in London honoring outgoing Bank of England governor Mervyn King. Summers gave us a glimpse of his views on the role of central bankers in a global economy still healing from the crisis. We parse a few excerpts for clues about the philosophy Summers could bring to the Fed.
On the need for new macroeconomic models:
No one would suppose if more enlightened macroeconomic and regulatory policy had mitigated what we have experienced for the last six years, that somehow all of the output that was lost, all of the employment that was lost, would somehow have been shaved off in some future boom. The significance of stabilization policy becomes that much greater, and the type of model that is necessary a model of periodic malfunction, becomes quite different from a model that presumes a constant mean.
Translation: Summers argued that the goal of monetary policy is changing. Instead of focusing on reducing volatility in the near-term, central banks should concentrate on preventing disasters. That suggests he might at least be open to raising interest rates to pop emerging bubbles.
On cyclical vs. structural change:
The traditional breakdown between the cyclical and structural that is central to macroeconomic thinking has become highly problematic. If there’s anyone in this room who believes that a reasonable forecast for the U.S. or British economy at any future date would be represented by a trend line constructed through 2007 from any previous point, I have a bridge that I would like to sell you.
Translation: Current Fed Chairman Ben S. Bernanke has been stalwart in his belief that the problems facing the economy are predominantly temporary and that the Fed can help the recovery take off by stoking demand through low interest rates. But Summers seems to give more weight to the argument that the levels of economic activity before the crisis were artificially high due to bubbles and that the economy is undergoing a more fundamental shift -- and that the Fed has limited power to counteract a structural change.
On the central bankers’ toolkit:
When central banks are most important, they’re doing something for which their complete insulation at least raises more questions.
If you have more targets, it’s good if you can think of more instruments … As the aspirations for the kinds of problems that central banks are going to avoid proliferate, there’s an inevitable desire for them to have more instruments.
Translation: Summers is known as an outside-the-box problem solver, a method that has become critical to central banks in the aftermath of the financial crisis. The Fed has deployed untested new tools to stave off depression and goose the recovery. Summers seems likely to continue to push the boundaries of the Fed’s power.
Just as the woes of the last five or six years reflect in part the fact that the lesson of the distant past about financial stability and the need to maintain demand were forgotten, there is the risk that in the aftermath of this episode, the lessons of the 1980s and 1990s about the importance of credibility in resisting inflation will be forgotten.
Translation: Do we smell a hawk?
[This comment came after Axel Weber, former Bundesbank president and monetary uber-hawk, discussed his concerns about the long-term consequences of easy monetary policy.]
I do not believe that the long run can be ceded to the avatars of austerity. Yes, I am the father or stepfather of six children, and, yes, on their behalf I am concerned about the possibility that an overly inflationary psychology will develop in my country. Yes, on their behalf, I am concerned that an excessive debt will be placed on them.
But I am vastly more concerned, because I care about their long-run future, that a slack economy will not provide them with satisfactory jobs when they leave school. I am more concerned, on behalf of their future, that they will live in a country with decaying infrastructure that will not permit investment that maintains leadership. I am more concerned on their behalf that inadequate resources forced by countercyclical austerity will stunt the ability of their generation to be educated. I am more concerned on their behalf that excessively austerity-oriented policies will lead to slower economic growth, and as a consequence, to an ultimately higher debt-to-GDP ratio and more pressure in terms of higher tax burdens in the future.
Those concerns, which come out of the proper management of current conditions, seem to me to be a larger concern for the long run than the concern that somehow unstable, overly expansionary policy starting from where we are now will stunt the opportunities that are open to them.
Translation: Okay, maybe not a hawk. But likely not as dovish the other leading candidate for the top job, Fed Vice Chairwoman Janet Yellen. Also, he has has six kids?!
You can read Summers’s entire speech here.
Or watch the video of the event, complete with Q&A, here.