CAMBRIDGE – The need to stimulate demand in the United States and other developed economies has provoked a debate that goes beyond economic technicalities to questions about government’s overarching responsibilities. Like the great economist John Maynard Keynes before them, Larry Summers and Paul Krugman have advocated a greater role for public spending to compensate for weak private-sector demand. But the justification for such a policy must transcend economic logic if it is to win political support. A greater role for government requires an overriding mission.
At an IMF Conference last November, Summers invoked the specter of “secular stagnation,” a condition in which aggregate demand persistently falls short of potential supply, generating under-employment and slow, if any, growth. Summers suggested that a speculative and unsustainable financial bubble had been required to create even a simulacrum of full employment in the decade or so before the crash.
Unfortunately, that bubble also led to the 2008 global financial crisis and the subsequent Great Recession. Moreover, recovery from the nadir in 2009 has been frustratingly slow, with employment as a proportion of the working population remaining virtually unchanged. According to Krugman, this is a familiar story – consider the failure of the late-1990’s tech bubble to generate sustainable growth – that goes back three decades.
Both Summers and Krugman argue that one of the biggest constraints on monetary policy during such crises is the “zero lower bound” for the policy interest rate. They suggest that the real rate of interest at which investment and savings would reach equilibrium at a level of output consistent with full employment is now negative. Unfortunately, they acknowledge that the alternative of a debt-financed fiscal stimulus would also be impossible in America’s current political climate.