Jeremiah has been raving that all monetary easing since QE1 has been overkill. Outside of the establishment economists in Washington, this is the majority view. Everyone from fund managers to Occupy says the Fed is not helping – the former, even as they rake in profits. Now, we have unearthed a paper that gives a name to the problem.
But first, here is Larry Summers speaking at the IMF economic forum. If you can’t open the FT link, watch the speech on YouTube. Summers has the nerve to say out loud what the others now claim to have been thinking all along.
Four years ago, the financial panic had been arrested … but, in those four years, the share of adults who are working has not increased at all. GDP has fallen further behind [its] potential …
This may be why Summers was dropped from the short list for Fed Chairman. He says there should have been a rebound after the crisis. Summers goes on to suggest that our equilibrium interest rate may be negative, and he draws a parallel with secular stagnation in Japan. The implication is that we only have full employment during a bubble, and – we may have been in this structural trap since the 1990s.
About ten years ago, Robert Dugger studied the situation in Japan. Recently, people have taken new interest in his work. We found this on Minyanville, and the original paper is here. The charm of Dugger’s paper is that, reasoning from Japan’s experience, he was able to predict exactly how such a situation would unfold in America. The details are uncanny. You would think he had just written it last week.
In a structural trap. extremely loose monetary policy perpetuates deflation and low GDP growth, because unproductive but politically important firms are allowed to survive and capital reallocation is prevented.
A structural trap looks like a liquidity trap, except that the Fed can’t generate a credible expectation of inflation – because everybody knows the real economy is flat on its back. What it takes to revive the economy is that you have to let old line companies go bust, so that workers – mostly young workers – can get new jobs in new industries.
That’s a lot of pain, but it would be over by now. The alternative is that we languish in this weak recovery, possibly forever. Larry Summers actually said forever. Japan is going on twenty years.
Dugger recognized that no politician has the nerve for this, and that’s where an independent central bank comes in. Remember Chairman Volcker tightening the screws in the 1980s?
Now that he is not facing another election, President Obama can afford to be bold. He should appoint a monetary hawk as Chairman, and pursue a policy of structural reform. That may be a stretch for the man who bailed out GM, but we can hope.