Sunday, December 29, 2013

Larry Summers and lower real rates

There is a growing consensus that the US and the world needs more stimulus for longer. Certainly, this should not be surprising given the size of the output gap that has not been closed almost five years since the bottom of the recession. This is also not surprising given the forecasts provided by those who have looked at past balance sheet recessions.

Forget about tapering, the view from the leading monetary economists is that we have to keep real rates even lower for more years to solve the great potential growth gap. The new theme in macroeconomics going back in time to the work of Alvin Hansen is secular stagnation and the Larry Summers is at the vanguard for stating that more has to be done.

The action which is being called for by Summers is a combination of more classic Keynesian economics. Fiscal policy will be more effective at low interest rates, and monetary policy is needed to keep real rates negative. what is startling about the Summers proposal is that it is very clear on the impact for savers - they should be penalized. Rates should be held down in a manner that would be consistent with the Keynesian view of "euthanizing the rentier class". The only way to close the output gap is make money as cheap as possible to push activity forward. Additionally, Summers is willing to accept the risk of a bubbles as simple cost to get the output gap closed. How can we obtain a wealth effect if there will be maker bubbles that will burst.

I am not sure how this is going to help investment and savings if we accept bubble risk and drive down real rates to unacceptable levels. This is truly unchartered territory that could spell disaster for those who are savers but do not have the skill or funds to adapt to this risky environment. 

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