Our February 6 interview with former U.S. Treasury Secretary and big all-around economic thinker of many hats Larry Summers covered a lot of ground. From his fears of a “secular stagnation” to his thoughts on New York City’s troubled J.F.K. International Airport (he finds it embarrassing).
Here are some highlights from our conversation with Summers.
Summers on economic development, fiscal stimulus and J.F.K. International Airport
Tom Ashbrook: Larry Summers, welcome back to On Point.
Larry Summers: Glad to be with you.
TA: You’ve been making a lot of noise at a lot of economic gatherings about secular stagnation and deep problems still in the U.S. economy, maybe the global economy. What’s the heart of your case?
LS: It’s been a long time since we had healthy, strong economic growth in a full capacity economy. We solved, we addressed, we prevented the financial crisis of 2008-2009 from becoming a depression. But since 2009, it’s been four and a half years since the recession ended, and the share of American adults who are working is essentially where it was at the trough. The output level has not really kept up with natural population growth and normal productivity growth. The reality is, that if you look before this crisis, yes, economic growth was reasonably satisfactory from 2004 to 2007, but that was only in the face of the mother of all credit bubbles, the huge bubble that took place in housing. The vast erosion of lending standards. Before that, we had a recession. And so, the reality is that our ability to have reasonable economic growth along with reasonably financial conditions is in question. And that’s why I think there are quite profound policy challenges going forward.
TA: The way out?
LS: Look, there are a number of ways of responding to this situation which I talk about in the American context, Tom, but it’s a context that really exists in Europe and japan to a very substantial extent, with Europe facing the prospect of deflation and Japan really struggling to come out of a decade of deflation.
There are really three ways of responding to the problem. One, which I think is the first is to simply hope for the best and not do much. The consequences of doing that is that eventually, you’ll close your output gap, but the way you’ll close your output gap is that the economy’s potential will come down.
TA: Explain what you mean by output gap and closing it?
LS: What we’ve had basically for years is an economy that’s been underachieving. It’s got the capacity to produce much more output then it has produced and there hasn’t been enough demand, and so people don’t produce more meals in their restaurant cause only so many people com in. Eventually, if we don’t do anything, we’ll have less and less investment, more and more people will give up on the idea of being workers
TA: Just a weaker, poorer economy.
LS: It will be a poorer, weaker economy, but at least we’ll be up to our potential. It’ll just be a much lower potential. That’s gotta be a terrible way to respond.
TA: Let’s say that’s not real attractive.
LS: A second way to respond, and it’s certainly better than doing nothing, is by trying as hard we can to create as loose and liquid financial conditions as we can so as to cause asset prices to go up and make people feel wealthy, so as to encourage as much borrowing as can take place.
TA: Isnt this what we’ve been doing with interest rates?
LS: But the danger there is that it’s better than just leaving people to be unemployed, but it runs the risk of reigniting the kinds of problems we had between 2005 and 2007.
LS: Bubbles, and bubbles that burst. There’s the problem that just how good is the investment that people were not willing to make when the interest rate was two percent, but are willing to make if you can drive down the interest rate to a much lower level, as illustrated by the fact there’s two and a half trillion dollars of cash sitting on corporate balance sheets simply sterile, not doing anything. There’s a question as to just how effective these kinds of policies are gonna be.
TA: This second path?
LS: So I approve of the attempt, but I think there are real limits both of efficacy and of potentially toxic side effects.
TA: Just for clarity, the second path it sounds like the path we’re on,
LS: That’s broadly been the strategy.
TA: Interest rates couldn’t be lower, there’s been a whole lot of transfusions from the Fed.
LS: Yeah, well we’ve pulled back on it a bit, but broadly that’s been the strategy. The third strategy which is the one that I’ve think we’ve been doing actually n the wrong direction the last three years, is to try to directly stimulate spending. Not by reducing interest rates, but by stimulating a higher level of spending at any given level of interest rates, and here it seems to be me the strongest candidate is public investment. Look at Kennedy Airport. Nobody could be proud of Kennedy Airport as the gateway to the greatest city in the greatest country in the world
TA: It’s old now, it’s falling apart
LS: It’s old, it’s falling apart. No place you fly to from Kennedy Airport is as decrepit as Kennedy Airport. And I would just ask the question, if a moment if we can borrow money for the long-term in a currency we print ourselves is below three percent. At a moment when construction unemployment is just about in double digits. If that’s not the moment to fix Kennedy Airport, when would that moment ever be?
Summers on inequality, entitlement reform, and the deficit:
Larry Summers: If we are able to increase the growth rate of this economy by two tenths of a percent, some people would say it was three tenths, but between two and three tenths of a percent for the next 75 years, that eliminates the entire deficit problem as it is now projected. And I ask you which is a better strategy, a more positive strategy, a more politically attractive strategy, a strategy that will have great other benefits? Doing all the things, tax reform, immigration reform, removal of barriers to private investment, necessary public infrastructure investment, to raise the growth rate by a quarter of a percent a year, or to launch an attack on programs that are giving people thirty thousand dollars a year, thirty five thousand dollars a year at maximum, at maximum. If you get the maximum social security benefit you possibly can get—
Tom Ashbrook: The entitlement reform question?
LS: Social security reform. The largest social security reform you can get. You pay the maximum in every year for your whole life time, it is less than 40,000 dollars a year. And so at a time of rising inequality, making the focus of our national effort to fix our economy be bearing down on social security beneficiaries, I just don’t think is the right approach.
On whether or not he takes any responsibility for the 2008 financial crisis, could the 2008 crisis happen again, did he supporting the deregulationist in Congress in the 1990s, and his thoughts on former US Commodity Futures Trading Commission chair Gary Gensler:
LS: I think all of us who served in-who’s been involved one way or another in the financial sector wish that we had foreseen all the things that took place in 2008 and been able to put in place preparations and contingencies that would have dealt more satisfactorily with those problems.
TA: Were they outgrowths of mistakes made by you in the 90s?
LS: I think there is much- I think with respect it is a very complicated tale. A wide variety of regulatory proposals that would have addressed many of the serious problems: putting derivatives on exchanges, doing something about predatorily mortgages, fixing Fannie and Freddie, that I and others put forward during the 1990s were not accepted by the Congress. The Congress at that point was in the thrall of aggressive deregulationists who would only pass legislation in one direction and of one kind—
TA: Weren’t you in their corner?
LS: No I was not in their corner with respect to a variety of proposals that I put forward, particularly with regard to predatorily lending, but also with respect to other issues that were reject. Now I was not someone who was willing to oversimplify the issue into the view that all regulation is good and all reductions in regulations are bad. And so there were measure that I believe were constructive that operated to reduce regulations that weren’t functional. And I did support those in the 1990s and I don’t believe you can make a case that the regulations whose removals or adjustments I supported were contributors to the 2008 financial crisis in any large way?
TA: The whole derivatives bubble and meltdown?
LS: There were important derivatives issues, but if you look at what was being done before the legislation and after the legislation it is not that the legislation addressed the things that were at the center of those derivatives problems. The derivatives problems, Tom, had to do with what are referred to as credit default swaps. Credit default swaps essentially were in their very infancy at the time when the Clinton Administration left office. The issues in derivivates were things that were entirely different during the time of the Clinton administration. The question is why nothing was done about credit default swamps and their various consequences over the subsequent eight years. That is an important question, but it is not one that should be addressed to those of us who served during the Clinton administration.
TA: Is that fix today? Is that risk fixed today, as we talk today are we still vulnerable to another 2008 kind of meltdown? You talk throughout here about the risk of that returning.
LS: Generals always fight the last war. And there is always a risk that while a number of those particular issues that were pointed up by the 2008 crisis have been address—are there continuing risks of financial instability? Yes. Has the last word been written, on regulation? No. Do we need to address, for example, a shadow banking system that is still very much in the shadows, as far as regulation is concern?
TA: swamps, derivatives…
LS: Absolutely. Are there continuing challenges with respect to derivatives? Yes there certainly are. But I do believe that important progress has been made and I certainly was very pleased to have, looking back, to have been very strongly supportive of the appointment of Gary Gensler at the CFCT and of the various things that he was able to accomplish that I do think make the system safer than they were before.
On the advice he would give to the new Chairman of the Federal Reserve, Janet Yellen:
TA: Janet Yellen stepping into the Fed, you’re not. What’s your one word of advice to her.
LS: Prudence! And I’m sure she’ll bring it.