Interview: Larry Summers

As the director of the National Economic Council, Larry Summers played a crucial role in shaping Barack Obama’s response to the global economic crisis during the U.S. president’s first two years in office. Summers, who earlier served as President Bill Clinton’s Treasury secretary during a period of robust economic growth and deregulation, urged Obama to recapitalize banks and pass the administration’s $787 billion economic stimulus package — all the while guided, as the New Yorker put it in a profile, "by an understanding that in financial crises the risk of doing too little is greater than doing too much."

Now a professor at Harvard University, where he previously served as president, Summers has taken to the op-ed pages to criticize European leaders’ incremental response to the debt crisis, call for fiscal and monetary expansion to fuel growth in Europe, and recommend that the IMF carry out adjustment programs on the continent. He’s a passionate Keynesian but not a rigid ideologue, as his shift in focus from deficit reduction under Clinton to deficit spending under Obama attests. "Keynes famously said of someone who accused him of inconsistency: ‘When circumstances change, I change my opinion,’" Summers explained in 2009.

Summers told Foreign Policy that the actions he has seen so far from European leaders suggest there’s still "a lot more tunnel" ahead in the debt debacle, though he thinks the European Central Bank (ECB) can have a significant impact on the crisis — if it steps up purchases of Italian and Spanish bonds. But on a darker note, he says that there are "limits" to what the Obama administration can do on its own to shield the United States from European contagion, and he warns of the disastrous effects that European bank retrenchment could have on the U.S. economy and global financial system.

Foreign Policy: In the latest developments in the European debt crisis, the ECB cut interest rates but dampened speculation that it will turn to the IMF for bond purchases or ramp up its own bond-purchase program. European leaders, meanwhile, announced an intergovernmental treaty while the British dissented. Can these actions break the cycle of crisis summits we’ve seen?

Larry Summers: Once again, enough has been done to avert disaster but not enough to point towards decisive resolution. The weakness in Italian bond markets speaks to the limitations of the steps agreed to so far. It is essential that there be a sound long-run framework. There’s no point in having heart surgery unless you are going to improve your diet afterwards. But at the same time, while you’re still in the intensive care unit, there are many issues that need to be attended to before you get to the diet.

FP: You’ve pointed to the IMF as a place where the policy response to the debt crisis needs to shift. Why?

LS: The global economy has a major stake in what happens, and the IMF is representative of the global economy. I think that an IMF presence could add significant credibility to what is happening in Europe, and I believe that the IMF could be one component of what is a very substantial amount of funding that is going to be needed. The IMF is necessary — but very far from sufficient.

FP: How does the ECB compare to the Federal Reserve? Does it have robust-enough policy tools to have a meaningful impact on the debt crisis?

LS: The ECB clearly has the potential to have a very large impact. The overall posture of monetary policy makes a profound difference in any financial crisis. Quantitative easing in Europe involves very substantial purchases of Italian and Spanish bonds even if it’s implemented simply proportional to outstanding debt.

FP: Former ECB President Jean-Claude Trichet was criticized by some for his interest rate hikes. Is the current president, Mario Draghi, up to the task at hand?

LS: I think Mario Draghi is an extraordinarily knowledgeable and seasoned policymaker. I’m very glad to see him at the ECB.

FP: At the start of the latest Brussels summit, Angela Merkel said European leaders must restore the euro’s lost credibility. But you’ve criticized policymakers for undermining confidence by making dubious assertions about, say, Greece’s solvency. Is it European leaders themselves who have lost credibility?

LS: There’ve been too many statements that shouldn’t have been believed at the moment they were made regarding the certainty of Greek solvency, regarding the certainty that a financial accident would be avoided, regarding the likely growth outlook for countries pursuing austerity strategies. And I think it would be helpful if we can move beyond that.

FP: Given that record, can credibility be restored by the leaders currently navigating this crisis?

LS: I don’t think credibility is like a light switch. I think over time, with actions, credibility can be enhanced.

FP: Are the central actors in this drama — Merkel, Sarkozy, Cameron — playing too much to domestic constituencies or focusing too much on near-term considerations?

LS: It is very difficult to sit from the outside and judge the actions of a political leader who faces many constraints and many pressures, not all of which one can understand on the other side of the Atlantic. I would not be inclined to sit in judgment.

FP: Moving to this side of the Atlantic, has the Obama administration taken the necessary steps to insulate the United States from European contagion?

LS: The principal problem for the United States economy over the near to medium term continues to be lack of demand. Demand, unfortunately, is heavily in the control of fiscal policy, which requires congressional action for important actions, and monetary policy, which depends on the Fed. So there are limits to what the Obama administration unilaterally can accomplish.

FP: You’ve raised concerns in the past about a banking crisis in Europe. Do you think that’s a real threat to the United States and the global economy?

LS: European banks have substantial exposures within the United States, and U.S. banks and European banks share common exposures around the world. So substantial retrenchment by European banks would have substantial adverse impacts on the U.S. economy and financial system. We have a stake in their success.

FP: What is the greatest threat to the global economy right now?

LS: In general, it is a vicious cycle of adverse economic development producing adverse financial development producing adverse economic development. And Europe is the epicenter of all that.

FP: Given what we’ve seen so far and the results of the latest eurozone summit, what does the future realistically hold for the monetary union and the European Union in general?

LS: There will need to be more crucial summits in the months ahead. There’s a lot more tunnel.

FP: Is that much more tunnel sustainable?

LS: I’ll leave it at that.