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How to Pull the World Economy Out of Its Rut

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Crazy things are happening in the world economy. In Europe and Japan, interest rates have turned negative, something long thought impossible. In the U.S., workers’ productivity is improving at the feeblest five-year rate since 1982. China is a confusing welter of slumping growth and asset bubbles.

Through it all, Federal Reserve Chair Janet Yellen practices the central banker’s art of draining the drama from any situation. She insists that conditions are returning to normal, albeit slowly. Her favored approach, “data dependence,” is nonpredictive and noncommittal, like finding your way in the dark by pointing a flashlight at your toes.

Lawrence Summers, the Harvard economist who almost got Yellen’s job, has no patience for such patience. Since losing out to Yellen in 2013, he’s been jetting around the world—from Santiago to St. Louis to Florence, Italy—to argue that the world economy is in much worse shape than central bankers understand. Focusing on monetary policy alone, he says, they’re doomed to fall short of reviving growth. They need to reach out to the governments they work for, he argues, and insist on strong fiscal stimulus in the form of infrastructure spending and the like. As an intellectual brawler from way back, he’s in his element.

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The jury’s still out on Yellen vs. Summers. Boring does not equal wrong, and provocative does not equal right. If the U.S. economy heals nicely over the next few years under business as usual, Yellen’s incrementalism will look smart. But the longer things stay weird, the more Summers appears to be onto something.

“My sense is that if Larry’s hypothesis is true, it’s a total game changer. It will affect how we think about macroeconomic policy for the next several decades,” says Gauti Eggertsson, an Iceland native who worked in the Federal Reserve System for eight years and is now a macroeconomic theorist at Brown University. In November, after Summers presented his ideas at the Peterson Institute for International Economics, its president, Adam Posen, himself a former policymaker at the Bank of England, blogged that “all of us in the profession have a lot of work to do” to respond to the “disturbing questions” Summers raised.

For economic policymakers, the most disturbing question is why global growth remains paltry and uneven. The annual growth rate of gross domestic product in the U.S. in the January-March quarter was just 0.5 percent. The euro zone was stronger than the U.S., at 2.2 percent; Japan, which has been flipping in and out of recessions for a quarter century, shrank 1.1 percent. Deflation once seemed to be a strictly Japanese problem—now it’s a worldwide threat. Pessimism about growth prospects is reflected in low forecasts for long-term interest rates. The annual yield on German 10-year notes is only 0.13 percent.

It wasn’t obvious in the summer of 2013, when President Obama was choosing between Yellen and Summers, that Summers would turn out to have such out-of-the-box ideas. Obama said that “when it comes down to their basic philosophy on the future of the Fed,” the differences between the candidates were so small “you couldn’t slide a paper between them,” according to Democratic Senator Dick Durbin of Illinois, who attended a meeting with the president. Both were highly credentialed—she as a longtime Fed official who was a labor economist at the University of California at Berkeley’s Haas School of Business; he as Treasury secretary under Bill Clinton, former Harvard University president, and former head of Obama’s National Economic Council. If anything, Yellen seemed more likely to be an activist Fed chair and “would probably be more committed to keeping stimulus in place until the economy was definitely recovered,” Michael Feroli, chief U.S. economist at JPMorgan Chase, said at the time.

But in November 2013, after Yellen was chosen but before she replaced Ben Bernanke as chair, Summers went to the International Monetary Fund in Washington and raised the specter of “secular stagnation,” a term coined in the Great Depression by Harvard economist Alvin Hansen, who lamented “sick recoveries which die in their infancy, and depressions which feed on themselves and leave a hard and seemingly immovable form of unemployment.” “Secular” is econospeak for long-lasting, as opposed to cyclical. Hansen’s warnings about secular stagnation seemed to be disproved when U.S. growth accelerated in World War II and then remained strong after the war stimulus ended.

For Summers, bringing the idea of secular stagnation back into the academic debate was like putting on a moldy old coat from Grandpa’s attic. But revive it he did. “Now, this may all be madness, and I may not have...


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