Two economists are stranded in a deserted conference room:
First Economist: What policy will lead to recovery?
First Economist: What policy will lead to recovery?
Second Economist (Larry Summers) : Increasing aggregate demand with deficit spending.
First Economist: How will that help?
Larry Summers: An increase in purchases will revive the ‘animal spirits’ of businessmen and induce them to invest and hire.
First Economist: How will the government finance its deficit?
Larry Summers: Assume an unlimited borrowing capacity.
This recycled economist joke is the sum and substance of Larry Summers’ advice to world leaders on the eve of the annual meeting of the World Economic Forum in Davos and it likely represents the collective wisdom of the elites who will be meeting there (see Prof. Summers’ FT article ‘Economic uncertainty is no excuse for inaction’ Jan 24). It is, of course, quite contentious.
The idea that an increase in demand will have the desired effect requires that businessmen think it will last –and there is no guarantee it will. John Stuart Mill made that point 150 years ago, when he wrote “the demand for commodities is not a demand for labor”. John Hicks, the creator of the ISLM model from which Mr. Summers’ opinion issues restated Mill’s critique a few decades ago, when he questioned the automatic link between increasing the demand for final goods and the inducement to invest. So, if the ability of government to sustain deficit spending is in doubt –and what sane person would not doubt it - then so is the likelihood it will have any good effect. And to bloat government deficits even further risks undermining the fiscal viability of the public sector-a prospect that could make today appear as a Golden Age in retrospect.
Mr. Summers is trapped inside a policy paradigm that simply does not apply anymore. We must look elsewhere for solutions to today’s problems. One avenue I suggest is to take seriously that we suffer from an over-indebtedness that constricts credit expansion and investment, and to implement policies to relieve homeowner debt and deleverage banks to increase both the supply and demand for credit in order to restore credit expansion–even if that means bank bondholders and banks themselves will need to suffer very large losses.
To adulterate a phrase from Keynes, we may need to implement a euthanasia of the (incumbent) banker. Now that is a thought likely to send a chill wind through Davos!
This recycled economist joke is the sum and substance of Larry Summers’ advice to world leaders on the eve of the annual meeting of the World Economic Forum in Davos and it likely represents the collective wisdom of the elites who will be meeting there (see Prof. Summers’ FT article ‘Economic uncertainty is no excuse for inaction’ Jan 24). It is, of course, quite contentious.
The idea that an increase in demand will have the desired effect requires that businessmen think it will last –and there is no guarantee it will. John Stuart Mill made that point 150 years ago, when he wrote “the demand for commodities is not a demand for labor”. John Hicks, the creator of the ISLM model from which Mr. Summers’ opinion issues restated Mill’s critique a few decades ago, when he questioned the automatic link between increasing the demand for final goods and the inducement to invest. So, if the ability of government to sustain deficit spending is in doubt –and what sane person would not doubt it - then so is the likelihood it will have any good effect. And to bloat government deficits even further risks undermining the fiscal viability of the public sector-a prospect that could make today appear as a Golden Age in retrospect.
Mr. Summers is trapped inside a policy paradigm that simply does not apply anymore. We must look elsewhere for solutions to today’s problems. One avenue I suggest is to take seriously that we suffer from an over-indebtedness that constricts credit expansion and investment, and to implement policies to relieve homeowner debt and deleverage banks to increase both the supply and demand for credit in order to restore credit expansion–even if that means bank bondholders and banks themselves will need to suffer very large losses.
To adulterate a phrase from Keynes, we may need to implement a euthanasia of the (incumbent) banker. Now that is a thought likely to send a chill wind through Davos!
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Great piece Luc
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