Larry Summers: evaluation

Transcript context

…No, no, no. It’s perfect. The Fed seems to consistently come in under 2 percent for inflation. Do you think this is just a systematic mistake? Do you think it’s a plan motivated by political economy concerns, that there’s a high political cost to being above two but a much lower cost to being below two? Do you think the implications of the semi-liquidity trap have not been fully digested yet? Do you think it’s a lag from an earlier error still percolating through the system? How do you think about the failure to meet 2 percent in an environment where, of course, it seems that if we had inflation being a bit higher, it would not be a major cost? I think the Fed has not fully grasped the reality of secular stagnation. The reality of secular stagnation is that we’ve got a very high savings propensity and a very low investment propensity. That means that the neutral real interest rate, the real interest rate that’s consistent with full employment, is very low. That means that interest rates, which would historically have been highly expansionary interest rates, are not highly expansionary. And the Fed has underestimated the extent to which that’s true. Therefore, they’ve been disappointed by how little inflation they’ve generated. I think that’s the primary explanation, a sort of analytical misjudgment on their part of the change in the neutral interest rate. I think, secondarily, the factors we were referring to a few moments ago, having to do with the reductions in workers’ leverage and bargaining power, means that a degree of tightness in labor markets that would in an earlier point have set off a wage spiral, no longer sets off a wage spiral because of how nervous workers are. So the Phillips curve relationship has either broken down or shifted, and the Fed has also underestimated that. Those are two aspects. Then separate from those two aspects, I think the Fed is confused in what it’s prepared to target. It says that it has a 2 percent inflation target. But if you have a 2 percent inflation target and it is, as the Fed claims, symmetric, that means you should be above 2 percent as often as you’ve been below 2 percent. We’ve been below 2 percent for nine years now. We’re in the ninth year of an economic recovery. The unemployment rate is at 4.3 percent. So if there was ever a time when you were going to be above 2 percent, it would seem like now — assuming recovery continues for several more years — would be that time. Yet not a single dot in the history of the FOMC has ever been above 2 percent, at least since the great financial crisis. So I think there’s a disconnect between what they’re prepared to forecast and what they say is the nature of the 2 percent target. My instincts would be to be more genuinely symmetric about the 2 percent and more recognizing the current policy is not quite as expansionary as they suppose, both of which would operate in the direction of caution with respect to monetary tightening. If there’s an ongoing demand shortfall, as is suggested by many secular stagnation approaches, does that mean monopoly cannot be a major economic problem because that’s from the supply side, and that the supply side constraint isn’t really binding if you think of there as being multiple Lagrangians. Forgive me for getting technical for a moment. Do you see what I’m saying?…

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