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Monday, April 27, 2009


summers at the IADB

via simon johnson at baseline scenario:

Summers made five points ....

  1. All crises must end. The “self-equilibrating” nature of the economy will ultimately prevail, although that may take massive one-off government actions. Such a crisis happens only ”three or four times” per century, so taking on huge amounts of government debt is fine; implicitly, we will grow out of that debt burden.
  2. We will get out of the crisis by encouraging exactly the kind of behaviors that “previously we wanted to discourage” two years ago. It is “this insight, this view” particularly with regard to leverage (overborrowing, to you and me) that “undergirds the policy program in the United States.”
  3. There is a critical need to support financial intermediation and to ensure it is adequately capitalized, with a view to the risks inherent in the current situation. He then said, with a straight face, that the current bank stress tests are designed with this in mind.
  4. Growth in the 1990s and more recently was based too much on finance (this appears to be a relatively new thought for Summers). The high and rising share of finance in corporate profits “should have been a warning”. The next expansion should be based less on asset bubbles and more on investment in key public services.
  5. The financial regulatory system “in fundamental respects has been a failure”. There have been too many serious crises in the past 20 years (yes, this statement was somewhat at odds with the low frequency of major crises statement in point 1).

in the first three points, summers is outlining a plan to use government balance sheet to sustain GDP by refinancing the private sector debt bubble while removing private sector reasons to precipitously deleverage as much as is possible. points four and five imply a realization that the private financial sector must be downsized relative to GDP over time.

johnson's tone indicates disapproval, but to be honest i don't think he has a better idea of what to do. indignation is easy, but this says much regarding the unrealism of his outlook:

There was nothing in Summers speech that addressed how we avoid - at the US or global level - becoming more like Japan in the 1990s, given the state of consumers’ and firms’ balance sheets around the world. There is no issue with debt levels; apparently, we can turn everything around with fiscal expansion and support for banks.

johnson has not yet accepted that japan was successful, indeed perhaps more successful than we can hope to be -- but i surely am glad that summers has. because it would appear that johnson's alternative plan is little short of embracing the armageddon of a self-reinforcing liquidation spiral.

The usual advice - given by the IMF, often at the behest of the US Treasury - is: manage an insolvency process for failed banks, precisely to reduce fiscal costs now and in the future, and to help restore confidence in the economy. Come to think of it, wasn’t this exact point made - forcefully and publicly - by Summers to the Japanese government during the 1990s?

johnson does not fully appreciate the ramifications of that plan, in my opinion, and is misguided in believing that touching off a liquidation spiral will somehow either reduce taxpayer costs or improve the general welfare. quite the opposite on both counts -- fiscal stimulus as massive as the american public's newfound propensity to save as a means of maintaining aggregate cash flows is probably the only means of avoiding both a pointless destruction of public welfare and a corresponding collapse of tax revenues.

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