There is a huge outstanding problem in economic policy today that almost nobody is talking about addressing. But Larry Summers is. Near the end of his recent talk at an IMF conference honoring Stanley Fischer, he rightly explained that we need to think about the “zero bound” problem for macroeconomic policy not as a weird thing that happened in 2008-2013 but as something that’s going to happen over and over again:
The zero bound problem, you’ll recall, is this. From the early eighties through to the mid-aughts there was a broad political consensus on how to fight recessions—you have the Fed cut interest rates. And from the 1950s through to the early 1980s “have the Fed cut interest rates” was part of the concensus view on how you fight recessions. But something funny happened in Japan in the late-1990s and then it happened in America in 2008-2009. Nominal interest rates went all the way down to zero.
At that point, things get controversial. One school of thought was that you should stimulate the economy with fiscal deficits. But of course the question of exactly what to spend money on or which taxes to cut became controversial. And the political controversy over specific stimulative measures soon blew up into a theoretical controversy about the desirability of doing stimulus at all. That left us with the other idea of “unconventional” monetary policy and various bouts of Quantitative Easing. Since the Fed has a different institutional structure from Congress, anti-QE sentiment hasn’t managed to stop it from happening. But it’s proven very controversial, the controversy has probably dissuaded the Fed from being more aggressive, and it’s not clear that future politicians will appoint QE-friendly Fed members.
That’s bad for right now. But it’s actually even worse for the next time around. Because it means that the next time the economy heads for a recession people will know that there’s no consensus around taking recession-fighting measures. Confidence and expectations could collapse very rapidly. I think the right short-term response is for congress to explicitly authorize helicopter drops and in the long-term to eliminate physical money and rely on e-currency to abolish the zero bound.
My ideas might be the wrong ones. But at least they’re ideas. Most policymaking institutions don’t even seem to be thinking about the next time around. But they should listen to Larry Summers. All this has happened before and all this will happen again.