Larry Summers, 14.462, and Wealth Illusions

Thanks to Mark Thoma, I came across a recent IMF Conference honoring Stanley Fischer, who I have called the Genghis Khan of macroeconomics.

If I were you, I would jump to the last video, on policy responses to the crisis. The panel features Ben Bernanke (who wrote his dissertation under Fischer), Fischer, Ken Rogoff (who wrote his dissertation under Dornbusch, but perhaps had Fischer on his committee), and Larry Summers, who went to grad school at Harvard but who spent a lot of time auditing courses at MIT, including Fischer’s monetary economics course, which Summers remembers as being called 14.462 in the MIT catalogue. The panel is chaired by Olivier Blanchard, long-time protege of Fischer, and the first question during the Q&A comes from Jeffrey Frankel, another Dornbusch student. I didn’t find Bernanke or Fischer so interesting, so I would recommend fast-forwarding to minute 33, when Rogoff is speaking.

Rogoff eventually says that one source of financial crisis is ordinary debt. One of the reasons that debt is over-utilized is that it often comes with a government guarantee, either explicit or implicit. One solution he proposes is to get rid of bank deposits. Instead, he would have the Fed run ATMs, and the only transaction accounts people would have would be deposits at the Fed, which I’m guessing would not earn interest. In order to earn interest, people would have to invest in risky securities.. (Rogoff was racing through his talk at this point, so I am doing some interpolation here that might not be exactly correct.)

36 years ago, these were my homies. Rogoff makes some amusing remarks about the macro wars of that time, and I think he correctly pinpoints Fischer and John Taylor as two economists who “bridged” the freshwater and saltwater schools. Later, Summers mocks Minnesota, just as in the old days.

Summers gives the most provocative talk, and it becomes the focus of much of the subsequent discussion. He asks why it was that for the decade prior to the financial crisis we needed the wealth illusions of bubbles in order to maintain an economy even close to full employment. He argues that the full-employment, non-bubble real interest rate must have been below zero for a long time, and that it may remain zero for a long time.

In response to Frankel’s question, Summers says that this situation can be attributed in part to Moore’s Law. Computers as a form of capital are characterized by decreasing prices, and this created a state of chronic excess supply in capital markets. The “savings glut” came not just from foreign sources but from the fact that the cost of obtaining capital in the form of computing equipment kept falling, making investment demand too low to absorb savings.

He is talking about a Great Stagnation not of supply but of demand. As he points out at the start of his talk, nobody has suggested anything like it since the 1940s, with the “secular stagnation” hypothesis. (I think that one of the proponents of that hypothesis was Summers’ uncle, Paul Samuelson, but I may be wrong about that.)

If you start by thinking in terms of classical economics, there are so many problems with Summers’ story that one does not even know where to begin. However, among Fischer’s horde, he is taken seriously. Bernanke does push back, invoking Bohm-Bawerk, as taught to us by Samuelson, to point out the extreme and implausible implications of a negative interest rate.

The panel tends to reinforce my complaints about the homogeneity of professional thinking, which is due, in my view, to Fischer’s over-breeding. These are macroeconomists who became prominent in the 1980s and 1990s. How is it that they constitute the panel here? The equivalent would be watching a panel in 1980 that consisted entirely of economists from the generation that thought wage-price controls were the best tool for fighting inflation.

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One Response to Larry Summers, 14.462, and Wealth Illusions

  1. Jack PQ says:

    If the conference is in honor of Stanley Fischer, it makes sense the speakers are Fischer’s intellectual kids.

    More worrisome is that these intellectual children of just one MIT professor hold, or have held, or will hold, several key positions in Treasury, the Fed, etc.

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