Lawrence Summers

David Warsh: Long-term economic stagnation may be in the cards

This chart compares U.S. potential GDP under two Congressional Budget Office forecasts (one from 2007 and one from 2016) versus the actual GDP. It is based on a similar diagram from economist Lawrence Summers from 2014.   [24]

This chart compares U.S. potential GDP under two Congressional Budget Office forecasts (one from 2007 and one from 2016) versus the actual GDP. It is based on a similar diagram from economist Lawrence Summers from 2014.[24]


Sluggish economic growth has generated a number of catch phrases to describe the collective experience – “lost” decades, secular stagnation, the Japanese disease.  There can be little doubt that the U.S. has been living through such a period.  The expansion since June 2009, the trough of the last recession, is nearing the record set in the 1990s, 120 months, but no one will mistake the last 10 years for the wild and wooly ‘90s.

True, the unemployment rate is today very low. But GNP growth itself has been sub-par, wages have risen only slowly, interest rates have remained low, inflation has stayed below target, and the federal deficit has grown instead of vanishing. That’s what Lawrence Summers had in mind in 2013 when he revived the long-ago prophecy of his Harvard predecessor Alvin Hansen to warn of secular stagnation.

How long?  Indefinitely, answered Summers, without a considerable overhaul of the economic dogma that informs politics and policy.

Summers reiterated all this earlier this month in a paper with Lukasz Rachel, of the London School of Economics, a leader of the rising generation of macroeconomists, at the spring meeting of the Brookings Panel on Economic Activity. A savings glut developed over the course of the last generation was driving down the so-called neutral rate of interest – the point at which savings and investment balance at full employment. Bubbles and other sorts of asset misallocation remain a threat as long as interest rates remain low and out of alignment.

Bigger government deficits than those now considered prudent will be required, the economists say, to soak up private savings on the one hand, and, on the other, devise novel long-term investments designed make private investment attractive again.

This time Summers added a further warning.  Given that central banks have slashed their lending rates by 5 percentage points or more to combat recessions in the past, “there is the question of whether enough room can be generated to stabilize the economy when the next recession hits.”  Monetary policy may have reached its limits.

Rachel and Summers’s analysis is technical economics.  You can read it here. Financial Times columnist Martin Wolf’s account of their paper is here. Summers added some details in an op-ed article in The Washington Post that makes the argument less of an abstraction.

Hansen, an early convert to Keynesian views and for some years thereafter its leading American apostle, had feared that demographic trends and diminishing technological opportunities were reaching  a point  at which only government deficit spending could keep the economy at full employment.

[It was in his presidential address to the American Economic Association, in 1938, that Hansen spelled out his view. Slowing population growth, the closing of the American frontier, and the end of the 19th Century capital-goods boom would mean “sick recoveries which die in their infancy and which feed on themselves and leave a hard and unmovable core of unemployment.”]

That didn’t happen, writes Summers. “Sufficient remedies were found initially in wartime military spending, then in massive national projects such as building out the suburbs and reducing saving by allowing Social Security to meet retirement needs and making consumer credit widely available.”  But with the extravagant growth of private savings around the world since the 1980s, perhaps the situation that Hansen feared has risen anew.  Summers writes in the op-ed:

What has happened to private saving and private investment? Many things, including increases in saving caused by people having fewer children, more inequality, longer retirement periods and increased uncertainty. Probably more important, demand for private investment has fallen off as the economy’s structure has changed. Computing power costs a tiny fraction of what it used to. Malls have been replaced by e-commerce. People prefer small urban apartments to large suburban houses. Cars and appliances need to be replaced less often. In any event, the end of labor force growth means less demand for new capital.

In their paper, much the news Rachel and Summers offer is empirical. Real interest rates would have declined far more over the last fifty years, the economists say, if it weren’t for the large increases in government debt, pay-as-you-go pensions, and public health insurance expenditures that were put in place by, among other things, “the Reagan revolution.”  That neutral rate of interest, a conceptual apparatus designed to guide central bank policy, may have declined as much as 7 percentage points since 1970s, as savings have grown and tempting private investment opportunities have shrunk. The neutral rate would be several percentage points negative without the run-up to the level today’s trillion-dollar annual deficit. Summers continued.

The traditional Keynesian view, in which permanent depression is possible, is more right than the New Keynesian approach in which employment is attributed only to temporary price rigidities.

What to do, then, about all those private savings seeking “yield,” or at least a seemingly fair return? Summers offers a short list of options: bigger budget deficits, improved Social Security designed to reduce retirement savings, redistributions of income to poorer consumers with higher spending propensities, reductions in monopoly power, investment mandates (such as the retirement of coal-fired power plants) and other investment incentives.

Are there any changes in the offing of comparable magnitude to those that after World War II made Alvin Hansen seem an alarmist? Perhaps.  The world seems to be selling again into a long-lasting global contest, this time between the United States and China.  The problem posed by global warming is very real; what remains to be seen is the alacrity with which it is taken up.

And it’s worth remembering that all this takes place against the backdrop of the narrative that Thomas Piketty set out in 2014. In Capital in the Twenty-First Century (Harvard), the French economist reintroduced an argument even older than secular stagnation – the proposition that the rich were getting richer much faster that the world economy was growing, and that this inequality was profoundly destabilizing

A decade after the financial crisis cast macroeconomics into low regard, it is back in style.

David Warsh, a veteran political and economist essayist, and an economic historian, is proprietor of Somerville-based economicprincipals. com, where this piece first ran.


David Warsh: Kenneth Arrow, a kindly giant of economics


Kenneth Arrow died last week, at 95, as modestly as he lived. He had survived his economist wife of 70 years, Selma Schweitzer Arrow, by 18 months.   Of what I read in the obituaries, the most telling glimpse was one that his son David afforded the Associated Press.

“He was a very loving, caring father and a very, very humble man. He’d do the dishes every night and cared about people very much.  I think in his academic career, when people talk about it, it often sounds like numbers and probabilities. But a large focus of his work was how people matter.’’

Arrow’s nephew, former Treasury Secretary, Harvard University president, and himself an economist, Lawrence Summers, also provided an intimate view.

The next most germane observation could be ascribed to many persons over the years:  if Nobel Prizes were awarded solely to recognize dominant contributions to economic theory, the Stanford University economist would have won four or five.  As his friend Paul Samuelson once said, he was the foremost economic theorist of the second half of the twentieth century.

Arrow’s eminence is frequently ascribed, James Tobin-fashion (“don’t put all your eggs in one basket”) to the short summary of social choice, a sub-discipline he and Duncan Black more or less founded in 1948 (“No voting system is perfect”). But he also fundamentally shaped the price theory applications, decision making under uncertainty, growth economics and the economics of information.

Indeed, with his appropriation of the terms “moral hazard” and “adverse selection” from the insurance industry (he trained one summer to be an actuary), Arrow introduced psychology and strategy into a fledgling science that to that point had understood itself as the study of prices and quantities.

He later sought, without success, to rename the problems he had identified as those of “hidden action” and “hidden information.”  But the deed was done.  After the appearance of “Uncertainty and the Welfare Economics of Medical Care,” in 1963, economics gradually came to concern itself with the information differences that are absolutely ubiquitous in life – and with the incentives they create.


Arrow’s centrality to the present age is not well understood. My Web site, Economic Principals, among many others, has worked away on it for years.  Among his contributions, perhaps the least known, is what happened after he moved to Harvard University from Stanford, in 1968.

Since the late 19 Century, Harvard had long been, with Columbia University and the University of Chicago, one of three main centers of economic learning in the United States. With the Russian Revolution and rise of Nazi Germany, Princeton became a late starter after 1933.

After the loss of two brilliant graduates to the Massachusetts Institute of Technology – Paul Samuelson, in 1940, Robert Solow, in 1950 – the Harvard economics department entered a long period of relative decline. Excellent faculty (Howard Raiffa, Thomas Schelling, Hendrik Houthakker, for example) continued to attract excellent students (Vernon Smith, Robert Wilson, Richard Zeckhauser, Samuel Bowles, Thomas Sargent, Christopher Sims, Robert Barro among them, and, by extension, Fischer Black) but not the critical mass of National Science Foundation grant recipients who flocked to MIT. 


The latter would become the rising generation; familiar names today include Robert Merton, Joseph Stiglitz, Robert Hall, Eytan Sheshinski, George Akerlof, William Nordhaus, Martin Weitzman, Stanley Fischer, Robert Shiller, Paul Krugman, Ben Bernanke, and Jean Tirole. Relating the history of the Harvard department from its founding to the outbreak of World War II, Prof. Edward Mason pleaded with his editors, toward the end of the article, to permit him to delay the writing of the next chapter “until we are up again.”

By the early 1960s, Harvard economics had sloughed off the methodological conservatism and residual anti-Semitism that had cost it ITS leadership 20 years before. After losing a third brilliant graduate, Franklin Fischer, to MIT, the university resolved to reverse the course of events (about the same time they bet big on molecular biology). Successive chairmen John Dunlop and Richard Caves, hired three Clark Medal winners – Arrow (1957), Zvi Griliches (1965), and Dale Jorgenson (1971) – tenured Martin Feldstein, and brought John Meyer back from Yale (and, with him, from Manhattan, the National Bureau of Economic Research).

During the next 11 years, Arrow (and fellow theorist Jerry Green) taught many of the leaders of the generation that initiated the revolution in information economics.  They included Michael Spence, Elhanan Helpman, Eric Maskin, Roger Myerson, Jean-Jacques Laffont, and John Geanakoplos (not to mention scores of stellar undergraduates, including Jeffrey Sachs, James Poterba, and Robert Gibbons). Feldstein taught Summers and dozens of others. Harvard once again was among the top departments, this time in the world – especially after Maskin returned from MIT, followed by several others.  Someone will write up the story of those remarkable years someday.

All the while, Arrow returned to Stanford every summer, to preside over conferences at the Institute for Mathematical Studies in the Social Sciences, organized by Stanford professor Mordecai Kurz. It was at the IMSSS that many developments of the next generation took place.  By 1980, Arrow was ready to return to Stanford. But that’s a story for another day.


After he left, Harvard University Press published six volumes of his collected papers – Social Choice and Justice; General Equilibrium; Individual Choice under Certainty and Uncertainty; The Economics of Information; Production and Capital; and The Economics of Information.Earlier, he had published a volume of papers on planning written with his friend Leo Hurwicz, Studies in the Resource Allocation Process.


In 2005, Arrow attached an addendum to his autobiography on the Nobel Foundation site, to reflect a subtly changing reappraisal, his own and that of others, of the significance of his work. In 2009, he became founding editor, with Timothy Bresnahan, of The Annual Review of Economics. And in recent years, he began thinking of the next volumes of collected papers – perhaps as many as another six or even eight, including one on economics and ecology. Much more time will be required to see Kenneth Arrow in perspective.

David Warsh,  a veteran financial journalist and economic historian, is proprietor of


David Warsh: The high-speed bailout of 2009


I spent some hours last week browsing the newly released transcripts of Federal Open Market Committee meetings in 2009.  Mostly I relied on the extraordinary “live tour” and subsequent coverage by The Wall Street Journal team.

I was struck by how greatly the action had shifted to the incoming administration of President Barack Obama.   The acute-panic phase of the crisis was past, and relatively little of the drama of that troubled year is captured in the talk of monetary policy.

On Jan. 15, President George W. Bush asked Congress to authorize the incoming Obama administration to spend $350 billion in Troubled Asset Relief Program funds.  Obama was inaugurated Jan. 20.

Treasury Secretary Timothy Geithner on Feb. 10 announced a financial stabilization plan consisting mainly of stress tests for the nineteen largest bank holding companies.

In a conference call, Fed Chairman Ben Bernanke explained to the Federal Open Market Committee that the details were hazy. “It’s like selling a car: Only when the customer is sold on the leather seats do you actually reveal the price.”

On Feb. 17 Obama signed the American Recovery and Reinvestment Act of 2009, a stimulus package of around $800 billion in spending measures and tax cuts designed to promote economic recovery.

In March the Fed announced it planned to purchase $1.25 trillion of mortgage-backed securities in 2009, expanding the “quantitative easing” program it had begun the previous November.   Also the administration’s bailout of the auto industry was completed.

In May, Geithner reported that nine banks were judged sufficiently well capitalized to have passed the stress tests. Ten others would be required to raise additional capital by November.  Gradually the stabilization was recognized to have been a success.

And in August, Obama nominated Bernanke to a second term as Fed chairman. Senior White House adviser Lawrence Summers had been unsuccessful in his efforts to replace first Geithner, then Bernanke.  He would try again.

Bernanke’s book-length account of all this is expected in the fall. About the same time, U.S.  Court of Claims Judge Thomas Wheeler likely will have delivered a verdict in a lawsuit against the government alleging that Bernanke acted illegally when the Fed took control of insurance giant American International Group at the height of the crisis.

Meanwhile, Summers has been repositioning himself, perhaps hoping to return to the White House in a Hillary Clinton administration.  In a New York Times piece, ''Establishment Populism Rising,'' Thomas Edsall interviews the Harvard professor for an update on Summers’s thinking.

.                              xxx

I continue to get my news of Russia from even-handed Johnson’s Russia List – five issues last week alone, containing 188 items from the U.S., European and Russian press, most of which, needless to say, I did not read.  Two that I did stood out.

Jack Matlock, ambassador to the disintegrating Soviet Union under George H.W. Bush,  wrote  on his blog that the “knee-jerk” conviction that Vladimir Putin  was directly responsible for the deliberately shocking murder of Russian dissenter Boris Nemtsov overlooks other possibilities. “So far nothing is absolutely clear about this tragedy except that an able politician and fine man was gunned down in cold blood,” he concluded.

Peter Hitchens, in The Spectator, argued that It’s NATO that’s empire-building, not Putin. His principal authority, George Friedman, founder of the high-end publisher Stratfor, dates the current phase of the conflict from Putin’s refusal to go along with US policy in Syria in 2011.

.                         xxx

I was struck that when the Club of Growth asked Wisconsin Gov. Scott Walker about his foreign- policy credentials, he replied that he considered Ronald Reagan’s decision to fire striking federal air-traffic controllers in 1981 “the most important foreign-policy decision of his lifetime.”


{Added by New England Diary overseer: Walker said of the firings; "It sent a message not only across America, it sent a message around the world'' that "we weren't to be messed with.''}

When you’re a kid with a hammer, the whole world looks like a nail.

(Reagan speechwriter and Wall Street Journal columnist Peggy Noonan offered Walker some half-hearted backup and The Washington Post zeroed in on Walker’s  cram course in foreign policy.)

I mention it mainly ir to say that, having spent most of my life covering economic development, one way or another, I’d say that the skein of events more important to U.S. foreign policy than any other were those in which the march in Selma, Ala.,  commemorated this weekend played an important part.

David Warsh is proprietor of and a longtime financial journalist and economic historian.

David Warsh: Deconstructing the Great Panic of 2008



Lost decades, secular stagnation -- gloomy growth prospects are in the news. To understand the outlook, better first be clear about the recent past. The nature of what happened in September five years ago is now widely understood within expert circles. There was a full-fledged systemic banking panic, the first since the bank runs of the early1930s. But this account hasn’t yet gained widespread recognition among the public. There are several reasons.

For one thing, the main event came as a surprise even to those at the Federal Reserve and Treasury Departments who battled to end it. Others required more time to figure out how desperate had been the peril.

For another, the narrative of what had happened in financial markets was eclipsed by the presidential campaign and obscured by the rhetoric that came afterwards.

Finally, the agency that did the most to save the day, the Federal Reserve Board, had no natural constituency to tout its success in saving the day except the press, which was itself pretty severely disrupted at the time.

The standard account of the financial crisis is that subprime lending did it. Originate-to-distribute, shadow banking, the repeal of Glass-Steagall, credit default swaps, Fannie and Freddie, savings glut, lax oversight, greedy bankers, blah blah blah. An enormous amount of premium journalistic shoe leather went into detailing each part of the story. And all of it was pieced together in considerable detail (though with little verve) in the final report of the Financial Crisis Inquiry Commission in 2011.

The 25-page dissent that Republican members Keith Hennessey, Douglas Holtz-Eakin and Bill Thomas appended provided a lucid and terse synopsis of the stages of the crisis that is the best reading in the book.

But even their account omitted the cardinal fact that the Bush administration was still hoping for a soft landing in the summer of 2008. Nearly everyone understood there had been a bubble in house prices, and that subprime lending was a particular problem, but the sum that all subprime mortgages outstanding in 2007 was $1 trillion, less than the market as a whole occasionally lost on a bad day, whereas the evaporation of more than $8 trillion of paper wealth in the dot-com crash a few years earlier was followed by a relatively short and mild recession.

What made September 2008 so shocking was the unanticipated panic that followed the failure of the investment banking firm of Lehman Brothers. Ordinary bank runs – the kind of things you used to see in Frank Capra films such as "American Madness" and “It’s a Wonderful Life”– had been eliminated altogether after 1933 by the creation of federal deposit insurance.

Instead, this was a stampede of money-market wholesalers, with credit intermediaries running on other credit intermediaries in a system that had become so complicated and little understood after 40 years of unbridled growth that a new name had to be coined for its unfamiliar regions: the shadow banking system – an analysis thoroughly laid out by Gary Gorton, of Yale University’s School of Management, in "Slapped by the Invisible Hand'' (Oxford, 2010).

Rather than relying on government deposit insurance, which was designed to protect individual depositors, big institutional depositors had evolved a system employing collateral – the contracts known as sale and repurchase agreements, or repo – to protect the money they had lent to other firms. And it was the run on repo that threatened to melt down the global financial system. Bernanke told the Financial Crisis Inquiry Commission:

As a scholar of the Great Depression, I honestly believe that September and October of 2008 was the worst financial crisis in global history, including the Great Depression. If you look at the firms that came under pressure in that period… only one… was not of serious risk of failure…. So out of the thirteen, thirteen of the most important financial institutions in the United State, twelve were at risk of failure within a week or two.

Had those firms begun to spiral into bankruptcy, we would have entered a decade substantially worse than the 1930s.

Instead, the emergency was understood immediately and staunched by the Fed in its traditional role of lender of last resort and by the Treasury Department under the authority Congress granted in the form of the Troubled Asset Relief Program (though the latter aid required some confusing sleight- of-hand to be put to work).

By the end of the first full week in by October, when central bankers and finance ministers meeting in Washington issued a communique declaring that no systemically important institution would be allowed to fail, the rescue was more or less complete.

Only in November and December did the best economic departments begin to piece together what had happened.

When Barack Obama was elected, he had every reason to exaggerate the difficulty he faced – beginning with quickly glossing over his predecessor’s success in dealing with the crisis in favor of dwelling on his earlier miscalculations. It’s in the nature of politics, after all, to blame the guy who went before; that’s how you get elected. Political narrative divides the world into convenient four- and eight-year segments and assumes the world begins anew with each.

So when in September Obama hired Lawrence Summers, of Harvard University, to be his principal economic strategist, squeezing out the group that had counselled him during most of the campaign, principally Austan Goolsbee, of the University of Chicago, he implicitly embraced the political narrative and cast aside the economic chronicle. The Clinton administration, in which Summers had served for eight years, eventually as Treasury secretary, thereafter would be cast is the best possible light; the Bush administration in the worst; and key economic events, such as the financial deregulation that accelerated under Clinton, and the effective response to panic that took place under Bush, were subordinated to the crisis at hand, which had to do with restoring confidence.

The deep recession and the weakened banking system that Obama and his team inherited was serious business. At the beginning of 2008, Bush chief economist Edward Lazear had forecast that unemployment wouldn’t rise above 5 percent in a mild recession. It hit 6.6 percent on the eve of the election, its highest level in 14 years. By then panic had all but halted global order-taking for a hair-raising month or two, as industrial companies waited for assurance that the banking system would not collapse.

Thus having spent most of 2008 in a mild recession, shedding around 200,000 jobs a month, the economy started serious hemorrhaging in September, losing 700,000 jobs a month in the fourth quarter of 2008 and the first quarter of 2009. After Obama’s inauguration, attention turned to stimulus and the contentious debate over the American Recovery and Reinvestment Act. Summers’s team proposed an $800 billion stimulus and predicted that it would limit unemployment to 8 percent. Instead, joblessness topped out at 10.1 percent in October 2009. But at least the recovery began in June

What might have been different if Obama had chosen to tell a different story? To simply say what had happened in the months before he took office?

Had the administration settled on a narrative of the panic and its ill effects, and compared it to the panic of 1907, the subsequent story might have been very different. In 1907, a single man, J.P. Morgan, was able to organize his fellow financiers to take a series of steps, including limiting withdrawals, after the panic spread around the country, though not soon enough to avoid turning a mild recession into a major depression that lasted more than a year. The experience led, after five years of study and lobbying, to the creation of the Federal Reserve System.

If Obama had given the Fed credit for its performance in 2008, and stressed the bipartisan leadership that quickly emerged in the emergency, the emphasis on cooperation might have continued. If he had lobbied for “compensatory spending” (the term preferred in Chicago) instead of “stimulus,” the congressional debate might have been less acrimonious. And had he acknowledged the wholly unexpected nature of the threat that had been turn aside, instead of asserting a degree of mastery of the situation that his advisers did not possess, his administration might have gained more patience from the electorate in Ccngressional elections of 2010. Instead, the administration settled on the metaphor of the Great Depression and invited comparisons to the New Deal at every turn – except for one. Unlike Franklin Delano Roosevelt, Obama made no memorable speeches explaining events as he went along.

Not long after he left the White House, Summers explained his thinking in a conversation with Martin Wolf, of the Financial Times, before a meeting of the Institute for New Economic Thinking at Bretton Woods. N.H. He described the economic doctrines he had found useful in seeking to restore broad-based economic growth, in saving the auto companies from bankruptcy and considering the possibility of restructuring the banks (the government owned substantial positions in several of them through TARP when Obama took over). But there was no discussion of the nature of the shock the economy had received the autumn before he took office, and though he mentioned prominently Walter Bagehot, Hyman Minsky and Charles P. Kindleberger, all classic scholars of bank runs, the word panic never came up.

On the other hand, the parallel to the Panic of 1907 surfaced last month in a pointed speech by Bernanke himself to a research conference of the International Monetary Fund. The two crises shared many aspects, Bernanke noted: a weakening economy, an identifiable trigger, recent changes in the banking system that were little-understood and still less well-regulated, sharp declines in interbank lending as a cascade of asset “fire sales” began. And the same tools that the Fed employed to combat the crises in 2008 were those that Morgan had wielded in some degree a hundred years before – generous lending to troubled banks (liquidity provision, in banker-speak), balance-sheet strengthening (TARP-aid), and public disclosure of the condition of financial firms (stress tests). But Bernanke was once again eclipsed by Summers, who on the same program praised the Fed’s depression-prevention but announced that he had become concerned with “secular stagnation.”

The best what-the-profession-thinks post-mortem we have as yet is the result of a day-long conference last summer at the National Bureau of Economic Research. The conference observed the hundredth anniversary of the founding of the Fed. An all-star cast turned out, including former Fed chairman Paul Volcker and Bernanke (though neither historian of the Fed Allan Meltzer, of Carnegie Mellon University, or Fed critic John Taylor, of Stanford University, was invited). Gorton, of Yale, with Andrew Metrick, also of Yale, wrote on the Fed as regulator and lender of last resort. Julio Rotemberg, of Harvard Business School, wrote on the goals of monetary policy. Ricardo Reis, of Columbia University, wrote on central bank independence. It is not clear who made the decision to close the meeting, but the press was excluded from this remarkable event. The papers appear in the current issue of the Journal of Economic Perspectives.

It won’t be easy to tone down the extreme political partisanship of the years between 1992 and 2009 in order to provide a more persuasive narrative of the crisis and its implications for the future – for instance, to get people to understand that George W. Bush was one of the heroes of the crisis. Despite the cavalier behavior of the first six years of his presidency, his last two years in office were pretty good – especially the appointment of Bernanke and Treasury Secretary Henry Paulson. Bush clearly shares credit with Obama for a splendid instance of cooperation in the autumn of 2008. (Bush, Obama and John McCain met in the White House on Sept. 25, at the insistence of Sen. John McCain, in the interval before the House of Representatives relented and agreed to pass the TARP bill. Obama dominated the conversation, Bush was impressed, and, by most accounts, McCain made a fool of himself.)

The fifth anniversary retrospectives that appeared in the press in September were disappointing. Only Bloomberg BusinessWeek made a start, with its documentary “Hank,” referring to Paulson. The better story, however, should be called “Ben.” Perhaps the next station on the way to a better understanding will be the appearance of Timothy Geithner’s book, with Michael Grunwald, of Time magazine, currently scheduled to appear in May. There is a long way to go before this story enters the history books and the economics texts.

David Warsh is proprietor of, economic historian and along-time financial journalist. He was also a long-ago colleague of Robert Whitcomb.