Ah, Those Halcyon Days!

For those of you who are nostalgic for the Carter years, Lawrence Summers warns about the prospective return of one of the signal features of those years—stagflation:

My concern rests on several considerations. First, even though financial repair had largely taken place four years ago, recovery has kept up only with population growth and normal productivity growth in the United States and has been worse elsewhere in the industrial world.

Second, manifestly unsustainable bubbles and loosening of credit standards during the middle of the past decade along with very easy money were sufficient to drive only moderate economic growth.

Third, short-term interest rates are severely constrained by the zero lower bound: real rates may not be able to fall far enough to spur enough investment to lead to full employment.

Fourth, in such situations falling or lower-than-expected wages and prices are likely to worsen performance by encouraging consumers and investors to delay spending, and to redistribute income and wealth from high-spending debtors to low-spending creditors.

Although slow growth is obvious to anyone who cares to look around, I don’t see many signs of inflation at this point. In terms of price increases which is what most people think of if they do think about inflation, the greatest price increases remain in those areas in which supply is constrained and government plays the strongest role—healthcare and education. How willingness to pay can increase in the presence of a constrained supply without prices increasing is a puzzle to me.

13 comments… add one

  • TimH

    As someone who works in ‘organized medicine,’ it always shocks me how little most people – even smart, knowledgeable people – know about just how involved the government is in shaping the supply of doctors, through funding almost every residency position via Medicare. Thus, the government decides how many say, internists vs. general surgeons vs. gerontologists we know. (The total # of positions has remained fixed since the 90s, even as population has increased and we’ve gotten, as a nation, older.)

    The government controlling supply (of doctors) so tightly has not worked for us any better than it did the Soviets.

  • through funding almost every residency position via Medicare

    Or how large the subsidy was. The last time I checked it was upwards of $80,000 per resident per year. Something to consider when you hear complaints about the high cost of medical education.

  • Red Barchetta

    I don’t want to get into an inflation debate, but “inflation” depends on what suite of goods you are buying. An awful lot of people buy healthcare and education services. And a cute trick being employed is to not change price, but to change the quantity/packaging sold at that price. This is especially true in food.

    In any event – if this is a direct quote Mr. Summers has a misunderstanding.

    “.. real rates may not be able to fall far enough to spur enough investment to lead to full employment.”

    The world is awash in risk averse capital at low rates. But that capital will not finance growth and investment if real risk capital is not available to underwrite the risk. It will stay high in the cap structure. This is a basic misconception, generally held by people who are not real investors.

  • The world is awash in risk averse capital at low rates. But that capital will not finance growth and investment if real risk capital is not available to underwrite the risk.

    I really wish more people understood this.

  • Ben Wolf

    Third, short-term interest rates are severely constrained by the zero lower bound: real rates may not be able to fall far enough to spur enough investment to lead to full employment.

    The above statement is actually problematic. It indicates Larry is still stuck in a Walrasian real interest rate paradigm where markets can only clear once the rate falls to its “natural” level. Unfortunately for Lar-Lar (and his pal Kruggles) the notion of instantly adjusting prices is empirically a myth, and once that is recognized the notion of full-employment equilibrium goes out the window along with it. We live in a world of slow-changing prices, Hicksian fixprice and false signaling which make reliance on that mechanism a losing proposition.

    To put it more simply this sort of thinking is precisely the reason we are still in a deep hole.

  • Red Barchetta

    “I really wish more people understood this.”

    I figured you would. I can think of two rather frequent commenters who, I would suggest, have no idea what I even said.

    And further, (and I’m not going to dive into the weeds with the math) actual risk capital is most assuredly in short supply. Look at the demanded returns.

  • Andy

    The world is awash in risk averse capital at low rates. But that capital will not finance growth and investment if real risk capital is not available to underwrite the risk. It will stay high in the cap structure. This is a basic misconception, generally held by people who are not real investors.

    So, what can be done – is there a policy or set of policies the federal government could adopt to change that?

  • Red Barchetta

    Andy

    Don’t take this the wrong way, but I’m always fascinated by the reaction “what can the government do?” They do very, very little very well. Get out of the way would be a start. Government gives us Solyndra. (Just this AM I heard that Obama wants to meet with tech execs to “partner” in job creation. Be afraid, very afraid.) The basic gist is to not diminish or attempt to direct investment dollars. The people putting up the dollars – their own dollars – will do that.

    1. Cut the crap on tax increases on cap gains tax rates and, yes, carried interest, which is a creature of cap gains. (Call sam’s cardiologist) Accumulated capital was once earned income capital and taxed at OI. In every sense of the word it is double taxed. If you start from a premise that capital investment seeds productivity, innovation and jobs, then any impediment or diminishment is – pardon my French – just shooting your dick off. Tax income to fund the state, not capital formation. The tax capital crowd just get pissed off at what they view as outsized gains and inherited (read: unjust) wealth. Its jealousy, not thoughtful analysis with the greater good in mind.

    2. Yes, some regulation is necessary, but over-regulation is harmful. Ask anyone in the business about SarBox or Dodd-Frank. Just something for politicians to preen about and make the lefty crowd feel good for sticking it to the man. Not good for investment. And day in and day out regulations? A good third are just hapless government employees trying to justify their parasitic existence. Another impediment with tiny benefits.

    3. Stop making production inputs needlessly more expensive. What are the major inputs? Labor, energy and raw materials. Competition for labor will sort those prices out. Global warming legislation is needlessly increasing energy costs, even as the whole hoax is crumbling. Raw materials? Just one example: Think about how many things the price of corn affects, yet a government is supporting it. Insane. Regulatory capture, but insane.

    You get the idea.

  • Some of the reasons that the ” world is awash in risk averse capital at low rates” is due to the massive sovereign wealth funds which are, at least in part, the creatures of U. S. trade, transportation, environmental, and financial policies.

    My suggestion would be for our leaders to stop thinking of those sovereign wealth funds the way they do about domestic wealth and start thinking about them as they would ICBMs.

    Another factor is large public pension funds but those will become smaller in due course.

  • Red Barchetta

    Ask, and ye shall receive –

    Here is regulation at work. Pitting QE vs DF / Volker rule, from today’s ZH. Don’t you just love it?

    http://www.zerohedge.com/news/2013-12-17/first-volcker-rule-casualty-emerges-implications-could-roil-market

  • Red Barchetta

    SWF’s as ICBM’s might be a bit overwrought, Dave. As I’m sure you know, the SWF’s are primarily a creature of countries with natural resources looking to diversify or stabilize their income producing capability and future concerns about resource depletion. (That is, their concerns, not our policies.) I don’t think the portfolio composition is really well known, as it is proprietary, but from my business I know quite a lot finds its way into alternatives.

    As for public pension funds, that’s quite an interesting issue. because so many still publish their deficits with 7-8% investment return assumptions (read: laughable) they are beginning to increase allocations to alternatives. Thank you, helicopter Ben. But they will always have liquidity issues forcing them to retain sizable liquid positions, and just basic fiduciary duty to not put it all on red…………..or will they?

  • SWF’s as ICBM’s might be a bit overwrought, Dave.

    How so? They aren’t merely tools of economic interest but of national interest.

    As a sidecar observation there’s an argument to be made that the main reason for the economic crisis in 2006-2007 wasn’t financial policy, fiscal policy, or housing policy but a miscalculation by the Saudis on how far they could push the price of oil.

  • Red Barchetta

    Dave

    Do you have a fever? And I get crap about CRA even though I watched and heard with my own eyes and ears credit decisions being made a/c CRA.

    Moving on……

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