How should we respond to the next recession? That was the topic of an event held by the Brookings Institution's Hamilton Project, where I spoke Monday in Washington with White House budget director Sean Donovan. I argued a number of points that address current concerns.
First, I argued that the possible election of “Demagogue Donald” dwarfs congressional dysfunction as a threat to American prosperity. Beyond lunatic and incoherent budget and trade policies, Donald Trump would for the first time make political risk of the kind usually discussed in the context of Argentina, China or Russia relevant to the United States. How else to interpret threats to renegotiate debt, prosecute insubordinate publications and rip up treaties? Creeping fascism as an issue dwarfs macroeconomic policy!
Second, I cautioned that although 2009 could have seen a repeat of 1929-33 and it did not happen, there are no grounds for complacency. As the chart below illustrates, on current forecasts the economy will have performed as badly over the 2007-18 period as it did over the Depression period from 1929-40. The single most important issue for containing government debt burdens, increasing national security, encouraging more generosity toward the poor and raising middle-class standards of living is accelerating U.S. economic growth.
Third, I argued -- following my secular stagnation thesis -- that fiscal policy is now important as a stabilization policy tool in a way that has not been the case since the Depression. Historical evidence suggests a better than even chance of an officially declared recession in the next three years.
When recessions come, the Federal Reserve normally reduces real rates by four to five percentage points.
But there will in all likelihood be nothing like this amount of room when the next recession comes.
I say this with full awareness that the Fed has unconventional tools at its disposal in addition to simply lowering rates. But I think it is very unlikely that additional stimulus equivalent to more than 1.5 percentage points of Fed easing is feasible. After all, rates below negative-0.5 percent or negative-0.75 percent are impracticable in a society with cash and might actually hurt financial intermediation. Forward guidance is fine in principle, but when the next recession comes, expected that forward rates will be very low far into the future. And quantitative easing is surely already hitting diminishing returns with the yield curve flattening and markets functioning without the illiquidity premia of the early recovery period. "Helicopter money" is basically a form of fiscal policy, as I shall argue in a subsequent post, and cannot be carried out autonomously by the central bank.
There is an additional case for fiscal policy. The economy as it now stands requires remarkably low interest rates to grow adequately. These rates are an invitation to leverage, to reaching for yield, to financial engineering and to bubbles. Raising rates significantly, as many suggest, without doing anything else risks recession. So the right strategy is to raise demand so as to make financially sustainable growth. This comes back to fiscal policy along with measures such as tax, regulatory and immigration reform to spur private demand.
Fourth, I suggested a number of areas for expansionary fiscal policy both to make recession less likely and to respond when the next one comes. The decline in U.S. infrastructure investment is indefensible in light of recent declines in interest rates, employment opportunities and materials costs.
Other areas in which fiscal support seems desirable include housing -- where residential investment still lags badly -- and support for social security. I emphasized that social security is good economics when, as at present, the growth rate far exceeds the government borrowing rate. Further it raises demand without enlarging government deficits.
As I expect to discuss in subsequent posts, much of what economists thought they knew about macroeconomic policy needs to be reassessed in light of events. Just as the events of the 1970s and the emergence of stagflation throughout the industrial world led to new policy paradigms, I believe that recent events will force us to develop new approaches to thinking about economic fluctuations and inflation that will drive major changes in thinking about fiscal and monetary policy.
Lawrence H. Summers, the Charles W. Eliot university professor at Harvard, is a former Treasury secretary and director of the National Economic Council in the White House. He writes occasional posts on Wonkblog about issues of national and international economics and policymaking.