Earlier this week, Lawrence Summers, the former U.S. Treasury Secretary and Vice President of Development Economics and Chief Economist of the World Bank gave a grave warning at the European Central Bank conference in Portugal that developed nations are ill-equipped to deal with another recession, both politically and economically. He added that central banks should be cautious of raising interest rates to control inflation. As Summers puts it ‘The issue that’s preoccupied monetary policy for the generation before the financial crisis -- the avoidance of inflation -- is no longer the top issue’, believing that now the importance has shifted to the maintenance of sound growth and getting to full employment. In Summers’ view, central banks should see ‘the whites of their eyes’ on inflation before pulling the trigger on policy responses, believing that the dangers of a global economic downturn ‘dwarf and massively exceed any adverse consequences associated with inflation pushing a bit above 2 percent’. When asked about whether global economies have recovered from the global financial crisis, Summers believes that the massive stimulus that has led to inflated asset prices ‘has obscured the full picture’, and that central banks’ ammunition supply to fight any downturn is looking worryingly limited.
Summers has long believed that at least some global economies are in a state of secular stagnation arguing, ‘Some people think that the economies are growing, that shows that the secular stagnation theory was wrong’. However, his view is the polar opposite ‘I have exactly the opposite view: It required enormous fiscal stimulus to get the economies to grow even reasonably adequately and that demonstrates the validity of the secular stagnation thesis’. He went on to say ‘It may be that if policy stays on guard with relatively expansionary monetary policy, with fiscal policies that are traditionally regarded as imprudent, we may keep this going for a while.’ However, he gave a blunt warning that ‘we’re living with a very brittle economy’ and if and when it does happen, central bankers have nowhere to go. ‘Downturns happen’ he told Bloomberg, adding ‘When they happen, the normal playbook is to cut interest rates by 500 basis points, but there’s not going to be that kind of room’.
However, although Summers is not alone in fear of the global economy going pear-shaped, others are more confident in authorities ability to fight any downturns. Philip Lane, an ECB Governing Council member agreed that the picture painted although he believed that central banks do have the tools to fight a downturn. As he put it ‘What Larry didn’t focus on last night and what we will focus on as central bankers is interest-rate policy is just one of the tools’, adding ‘The range of tools a central bank can use to maintain its inflation target, even during a slowdown, is wide.’ However, will history repeat itself we ask, with the Japanese economic stagnation, ‘the lost years’, following asset prices collapsing still in the memory of central bankers globally, that even today, policymakers in Japan continue to grapple with the consequences.