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“Some Intellectual Provocation” - June 19, 2018

This week is the ECB’s Forum on Central Banking, which this year ‘explores the behavior of prices and wages in advanced economies, both from a macro- and a microeconomic perspective’. They advertise that there will be a variety of viewpoints and the speakers list is a veritable who’s who of the Central Bank world, with Kuroda, Draghi, and Powell all making appearances. Appearing yesterday, was none other than Lawrence “Larry” Summers, who was brought in to provide ‘some intellectual provocation’. No stranger to provocation, having been in the hot seat for remarks about women in science during his truncated time as President of Harvard University, Larry argued five propositions during his Forum speech:

1. The Financial Crisis led to little revision in basic monetary theory

2. The neutral real interest rate has declined by more than is generally accepted

3. This is plausibly attributable to structural factors in world economies

4. The world is at a moment where it is little able to withstand a recession

5. Monetary policy should focus on price stability and maximum unemployment.

In defending these propositions, Larry delivered some remarkable quotes:

“We leave the Financial Crisis period with the same paradigm with which we entered it, central banks explaining they can’t affect real things, that they can affect inflation, and so that needs to be their sole focuses even as their ability to affect inflation is in substantially more doubt than it was some years ago”.

Such doubt has inspired the BoJ’s recent decision to study, ‘how the rate [of inflation] has managed to defy a number of unorthodox monetary policies, the tight labor market and other factors.’

“... the expansionary fiscal policies that we have seen around the world have obscured what otherwise would be a much more precipitous decline in real interest rates.”

“There is a playbook for responding to recession... it has one central element: the reduction of interest rates by 500 basis points, that has been the elixir that has stopped recessions in the past... “

Which is a follow up to Summers’s previous warnings that, ‘in the next recession, monetary policy of the standard form will lack room to do what it usually does.’

“...suffice it to say that it is far more troubling that this [election of Trump] happened at a moment when the unemployment rate was in the low fours than it would have been if the unemployment had been in the eights, and that nothing about an economic downturn will do anything other than magnify the pressures for populism, for protectionism, and for a systematic breakdown and a return to economic nationalism.”

“The consequences of another economic downturn dwarf and massively exceed any adverse consequences associated with inflation pushing a bit above 2%”.

Finally, after exhorting the bankers present to do all they can to avoid an economic downturn, Summers concludes:

“And the goal of monetary policy, I submit, should therefore be the goal that our fellow citizens have for monetary policy, which is price stability, yes, but also maximum sustained full employment. And that is going to be an increasing challenge for us in the years ahead”.