Summers and the Road to Damascus Servaas Storm Sep 3, 2019
In what constitutes a volte-face, Lawrence Summers openly admits that monetary policy is ineffective in the current environment of secular stagnation and argues that what is needed instead are "efforts by governments to promote demand through fiscal policies and other means." Summers and co-author Anna Stansbury write that they have come to agree with "the point long stressed by writers in the post-Keynesian (or, perhaps more accurately, original Keynesian) tradition: the role of particular frictions and rigidities in underpinning economic fluctuations should be de-emphasized relative to a more fundamental lack of aggregate demand."
Pushing on a string
Summers and Stansbury are right in pointing out that the U.S. is suffering from a fundamental lack of demand. But they are wrong in believing that this is somehow only now showing up in a decline in the power of monetary policy to stimulate the economy. Monetary policy has never been robustly effective in promoting economic recovery or growth. While restrictive monetary policy, when credible, may be effective in slowing down economic growth and reducing inflation, this does not mean that monetary stimulus has the capacity to promote growth and raise inflation — if anything, post-2008 monetary policy experience provides an acid test of this asymmetry in policy effectiveness.....
Summers' U-turn appears to be motivated by a fear of the negative and destabilizing macroeconomic consequences of further interest rate reductions by central banks, and especially by the European Central Bank (ECB), which is currently charging commercial banks a penalty interest rate of 0.4% if they park surplus liquidity in Frankfurt; the ECB's refinancing rate is zero.....
But wait a minute: isn't the U.S. economy at full employment right now?....
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