In a major speech at the International Monetary Fund in early November, Larry Summers argued that the U.S. may need bubbles in the future to sustain strong economic growth.
Top Goldman Sachs economists disagree.
In the speech, Summers said that before the financial crisis, the housing bubble was still not enough to create adequate demand.
“Too easy money, too much borrowing, too much wealth,” Summers said of the pre-crisis period. “Was there a great boom? Capacity utilization wasn’t under any great pressure. Unemployment wasn’t under any remarkably low level. Inflation was entirely quiescent. So somehow, even a great bubble wasn’t enough to produce any excess in aggregate demand.”
His concern is that we will continue to need bubbles in the future to have strong growth and reach full employment. This is the theory of secular stagnation.
Enter Jan Hatzius and David Mericle, top economists at Goldman. They examined Summers’s thesis and found little evidence backing it up.
“Our view of the recent weakness is more cyclical than secular,” they write. “The slow rate of recovery in recent years is roughly in line with the performance of other economies following major financial crises, as shown by Reinhart and Rogoff, and the reasons for the weakness in aggregate demand over the last few years have now begun to diminish.”
Hatzius and Mericle look at Reinhart and Rogoff’s previous research on the big five financial crises in developed countries that were similar to the Great Recession in the United States. They find that the U.S. recovery has been slightly above average in comparison:
They see the current slow recovery as an effect of the crisis and not an indication of a larger secular problem with the economy.
In responding to Summers’s argument that the labour market was still loose in the mid-2000s even with the housing bubble, Hatzius and Mericle write that the economy was already near full employment after the 2001 recession and thus employment growth was bound to be slow. They also note that the price of oil and other commodities rose quickly during the period, inhibiting growth.
The idea that we will need financial bubbles to sustain full employment is worrisome. Hopefully Hatzius and Mericle are correct.