Daniel W. Drezner

This Bust is Different?

This Bust is Different?

Greetings from Beijing, where one can say simultaneously that a) the air is unhealthy; and b) comparatively speaking, this is good news relative to the air quality from last week. 

I’m sure the economic zeitgeist has moved past Larry Summers’ IMF speech from earlier this month.  It has received praise from Paul Krugman, Martin Wolf, James Pethokoukis, and Business Insider.  The precise from BI:

The Fed cut the rate to zero, but we still have had a slow recovery.

The problem is that the natural interest rate — where investment and savings bring about full employment — is now negative. However, the Fed cannot cut the nominal rate below zero because people will choose to hoard money instead of putting it in the bank. This is called the zero lower bound and has reduced the power of Fed policy….

If another recession were to hit now or in the next couple of years, the Fed will have even less power to combat it since rates are already at zero. This is what Summers warned of in his speech at the IMF.

"Imagine a situation where natural and equilibrium interest rates have fallen significantly below zero," Summers said. "Then conventional macroeconomic thinking leaves us in a very serious problem because we all seem to agree that whereas you can keep the federal funds rate at a low level forever, it’s much harder to do extraordinary measures beyond that forever, but the underlying problem may be there forever."….

I think that [what the] world has underinternalized," he said, "is that it is not over until it is over, and that is surely not right now and cannot be judged relative to the extent of financial panic, and that we may well need in the years ahead to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activities, holding our economies back below their potential."

Call this the "secular stagnation" hypothesis.   

Now let’s stipulate that Larry Summers is a much smarter person than I am in general, and that on macroeconomic policy he is several orders of magnitude smarter than I am.  Furthermore, an awful lot of smart people across the ideological spectrum in economics thinks he has made a Really Important Point.  And about half of my rational brain thinks he is right. 

Here’s the question the other half of my rational brain is pondering:  how much of this "secular stagnation" argument is the flip side of arguments made at the peak of a bubble proclaiming that the bubble is sustainable?  The longer an asset bubble lasts, the more intellectual arguments are made positing why the bubble is really the new normal, and economic reality has shifted (in a positive direction).  The longer a bubble lasts, the more smart people conclude that this time is different. 

A lot of attention has been focused on the errant prognostications and economic theories that emerge during boom times.  Has the same level of attention been paid to busts?  In other words, there’s a way in which Summers’ secular stagnation argument fits nicely with Tyler Cowen’s Great Stagnation argument or Robert Gordon’s technological slowdown hypothesis.  I’m not saying all of these arguments are completely wrong — but I am saying that they tend to become more fashionable to make during periods when economic growth is lackluster at best and negative at worst. 

As anemic as the recovery has been in the United States, it’s still been better than ex ante predictions would have been made based on Reinhart and Rogoff’s dataset on past financial crises.  So while I share the concerns voiced by pessimists, and kinda sorta worry that Summers is right, I do wonder if the economics commentariat is suffering from a version of This Bust Is Different. 

What do you think?