If there were any remaining doubt as to what Lawrence Summers would do, had he been named successor to Federal Reserve Chairman Ben Bernanke rather than Janet Yellen, an op-ed in Sunday’s Washington Post suggests a decidely dovish stance would have been forthcoming.
Yellen, who assumes her chairmanship of the Fed on Feb. 1, is thought to be accommodationist as well. Since she and Summers were President Barack Obama’s top choices for the Fed and since Summers had previously been the president’s economic policy advisor, Summers’ op-ed may reflect economic policy fears at the highest levels in Washington.
That overarching concern (which may, of course, reflect only the opinion of its author) is that the U.S. is in danger of sinking into a Japan-style stagnation, which, to be pre-empted, requires long-term “unconventional policy support” from the Fed.
as evidence of U.S. structural stagnation, Summers cites an economic recovery that has remained weak for four years running; a preceding decade of asset bubbles and loose credit, which produced only moderate economic growth; current rates which, at the zero bound, may be incapable of falling enough to spur greater investment in the economy; and falling or low wages and prices that discourage consumption.
Summers finds this new normal to be reminiscent of a Japan whose GDP today “is less than two-thirds of what most observers predicted a generation ago” despite many years of zero-bound rates.
Chillingly, he reports that “Japanese GDP was less disappointing in the five years after the bubbles burst at the end of the 1980s than U.S. GDP has been since 2008. U.S. GDP is more than 10% below what the Congressional Budget Office predicted before the financial crisis.”
Before addressing policy implications, Summers notes the possibility that an economy stuck in a stagnation trap simply won’t achieve escape velocity, noting the U.S. — like Japan in the 1990s — has seen many false dawns. Even if U.S. growth somehow accelerates at zero rates, he questions whether such growth can be sustained under normal rates.
Summers also suggests the possibility that policymakers are fighting against a new normal of structural constraints such as slowing labor force and productivity growth, declining consumption and increasing risk aversion.
So while low interest rates risk asset bubbles, Summers concludes that “the risk of financial instability provides yet another reason why pre-empting structural stagnation is profoundly important.”
Summers’ op-ed jibes well with the briefer statements that Janet Yellen made in her U.S. Senate confirmation hearing last month, when she said:
“It's important not to remove support, especially when the recovery is fragile and the tools available to monetary policy should the economy falter are limited, given the short-term interest rates are at zero. I believe it could be costly to withdraw accommodation or to fail to provide adequate accommodation.”
Market watchers are focused on the Federal Open Market Committee, which will decide on Wednesday whether to begin tapering the Fed’s $85 billion-a-month bond-buying program — a monetary tightening step short of raising the benchmark interest rate.
Talk of tapering in the spring led to a bond-market rout, rising rates followed by a retreat to a more cautious stance on tapering that fueled a subsequent market rally.
But an improved jobs report earlier this month has fueled speculation that Bernanke might initiate a modest reduction in the Fed’s bond buying starting this week.
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