1. Summers says:
I doubt that, if rates were now 4 per cent, there would be much pressure to raise them.I think what Summers means is that, if everything else looked the same, and if the interest rate on reserves were at 4%, then people might be drawing different policy conclusions. But of course, that's an odd counterfactual to be thinking about, as it's hard to imagine how everything else would look the same. So, consider the following counterfactual. The last time the fed funds rate was at 4% was in January of 2008. So, suppose at that time that the Fed had not reduced the fed funds rate target, but had maintained it at 4%. Suppose all other aspects of policy were the same - the interventions during the financial crisis, the Fed's balance sheet expansion etc., and that the Fed commenced paying interest on reserves at 4% in fall 2008, and maintained that until now. What would have been different? A long history of research in monetary economics - theory and empirical work - tells us that the recession would have likely been more painful and perhaps longer. But as of today, six years after the recession actually ended, on the real side of the economy things would not have looked much different. But with nominal interest rates at 4%, standard Irving Fisher economics - which is built into every monetary model that I know about - tells us that the inflation rate would be 4% higher. So in that sense, Summers is absolutely right. If rates were now at 4 per cent, and given the Fed's 2% inflation target, we would be missing the inflation target on the high side, and the pressures would be quite different.
2. Toward the end of his piece, Summers says:
Much more plausible is the view that, for reasons rooted in technological and demographic change and reinforced by greater regulation of the financial sector, the global economy has difficulty generating demand for all that can be produced. This is the “secular stagnation” diagnosis, or the very similar idea that Ben Bernanke, former Fed chairman, has urged of a “savings glut”. - See more at: http://larrysummers.com/2015/08/23/the-fed-looks-set-to-make-a-dangerous-mistake/#sthash.iJYo0wau.dpufAs I pointed out to a commenter on this previous post, savings gluts and secular stagnation are actually quite different. Summers and Bernanke are thinking in terms of a simple model of the credit market. There is a demand for loans determined in part by the demand for investment, with demand depending negatively on the real interest rate. There is a supply of loans that depends on savings behavior, and loan supply depends positively on the real interest rate. Secular stagnation is low demand which makes the real interest rate low, savings glut is high supply that makes the real interest rate low. Entirely different. Note further, that the measurements reported here seem to put the kabosh on the secular stagnation idea.
Paul Krugman agrees with Summers:
I’m with Larry here: this attitude has the makings of a big mistake. Think Japan 2000; think ECB 2011; think Sweden. Don’t do it.I think what he means is that Japan in 2000, the ECB in 2011, and Sweden (presumably 2011 also), did the wrong thing, saw the errors of their ways, and went back to zero or lower nominal interest rates. Currently, the overnight interest rate in Japan is 0.1%, the ECB deposit facility rate (the counterpart of the interest rate on reserves) is -0.2%, and the overnight interest rate in Sweden is -0.35%. It seems that Krugman approves of that, but the Bank of Japan, the ECB, and the Riksbank have certainly not been successful in achieving their goals. All of these central banks would like 2% inflation, but inflation in Japan is currently 0.4%, inflation in the Euro area is at 0.2%, and inflation in Sweden is at -0.1%. I'm sure Krugman (and Summers too) is thinking that a long period with very low nominal interest rates makes the inflation rate go up, but the last 20 years in Japan and this recent experience in other countries might make him want to think twice.