Larry Summers: Prudent Macro Policy
LHS:
How to ensure stimulus today, austerity tomorrow: Economic forecasters… are those who cannot know the future but think they can – and… those who recognise their inability to know the future. Major shifts in the economy are rarely forecast, and often not fully recognised until they have been under way for some time….
What can be said is that for the first time in five years a resumption of growth significantly above the economy’s potential now appears a substantial possibility…. Employment growth has been running well ahead of population growth for some time now. The stock market level is higher and its expected volatility lower than at any time since 2007…. Consumers who deferred purchases of cars and other durable goods have created pent-up demand that now seems to be emerging. At last the housing market seems to be stabilising…. [M]ore and more young people have moved in with their parents. At some point they will set out on their own, creating a virtuous circle….
True, the risks of high oil prices, further problems in Europe and financial fallout from anxiety about future deficits remain salient. However, unlike the situation in 2010 and 2011, these risks are probably already priced into markets and factored into outlooks….
What are the implications for macroeconomic policy? Such recovery as we are enjoying is less a reflection of the American economy’s natural resilience than of the extraordinary steps that both fiscal and monetary policy makers have taken to offset private sector deleveraging…. [T]he most serious risk to recovery over the next few years is no longer financial strain or external shocks, but that policy will shift too quickly away from its emphasis on maintaining adequate demand…. On even a pessimistic reading of the economy’s potential, unemployment remains 2 percentage points below normal levels, employment remains 5m jobs below potential levels and gross domestic product remains close to $1tn[/year] short of its potential…. [A] lurch back this year towards the kind of policies that are appropriate in normal times would be quite premature. Indeed… by slowing investment and increasing long-term employment, such policies could seriously damage the economy’s long-term performance. Brad Delong and I argued in a recent paper that premature and excessive fiscal contraction could even, by shrinking the economy, exacerbate budget problems in the long run.
How then to respond to valid concerns…? The right approach is to use contingent commitments – policies that commit to action to normalise conditions, but only when certain thresholds are crossed…maintain the current Fed Funds rate until some threshold with respect to unemployment or expected inflation is crossed…. [F]und infrastructure… [with] a financing mechanism such as a gasoline tax… triggered when some level of employment or output growth has been achieved…. Contingent commitments have the virtue of giving households and businesses clarity… eliminate political uncertainty… allow policy makers to make a simultaneous commitment to near-term expansion and medium-term prudence – exactly what we require…
