Former Treasury Secretary Larry Summers is the ultimate establishment figure. EricLevitz writes on how he became the preeminent critic of the Biden era’s economic consensus
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If the story is true, then Summers has ceased taking his own advice. These days, the former treasury secretary is the outsider — or at least he’s acting like one. Ten months later, times have changed. Today, inflation is eroding workers’ wage gains and the president’s poll numbers, while headlines tout Summers’s prescience and the president solicits his counsel.
If the American technocracy has a royal family, then Larry Summers was born into it. Both of his parents were distinguished economists; two of his uncles were Nobel Prize-winning ones. His paternal uncle, Paul Samuelson, was arguably the most influential U.S economist of the 20th century, laying the foundations on which a generation of liberal economics was built.
Samuelson’s theory of demand management had posited an inverse relationship between unemployment and inflation: When jobs were abundant, workers could hold out for high wages, thereby forcing employers to raise prices to compensate for rising labor costs; when jobs were scarce, employers could drive a hard bargain on pay rates, and thus keep prices low. Government’s task was to maintain an optimal balance between the competing goods of full employment and price stability.
As American politics grew more conservative, however, evidence-based economics seemed to do the same. The electoral ascent of Ronald Reagan’s GOP coincided with the academic triumph of Milton Friedman’s macroeconomics. Through it all, Summers’s research remained heterodox. But by the early 1990s, it was clear that his ideology lay to the right of his uncle’s.
If the supposed failure of Barack Obama’s “small, measly” stimulus emboldened Democrats to “go big” last year, it also inclined them to write off Larry Summers’s complaints about their party’s newfound fiscal ambition. After all, many saw Summers as the leading author of “the mistake of 2009.” In the Clinton era, this theory of growth was not reserved for the global economy’s up-and-comers. At Treasury, Summers worked under the wing of Robert Rubin, a Goldman Sachs alum and evangelist for “expansionary austerity.” In Rubin’s analysis, public spending “crowded out” private investment by pushing up long-term interest rates. The idea being: the more interest that firms needed to pay on borrowed capital, the less likely they would be to finance new plants or enterprises.
Events would flatter the pessimists. As the financial system’s implosion decimated the middle class’s 401ks and choked off credit to businesses, private spending and investment collapsed. By December 2008, the crisis had ripped a $1.7 trillion hole in the economy. Textbook Keynesianism — which is to say, the centrist kind that Summers was raised on — had a clear prescription for this circumstance: Public spending must fill the hole in private demand.
But the post-2008 recovery brought no such boom. Instead of accelerated growth, Obama’s first term witnessed a rate of economic expansion far below the long-term average. Today, the American economy is still smaller than it would have been, had the crash never happened. Oregon Senator Jeff Merkley had won his seat in 2009, after campaigning on an anti-bailout platform. One of Summers’s first tasks as NEC head had been to neutralize Merkley’s opposition to a second round of bailouts for the beleaguered financial system. To do so, he led Merkley to believe that, if he voted as the administration wished, the White House would fight hard to pass bankruptcy reforms that would make it easier for embattled homeowners to avoid foreclosure.
Two months after his bid for Fed chair was quashed, Summers appeared before the IMF Research Conference and delivered what was, in the words of New York Times columnist Paul Krugman, “a very radical manifesto.” But in the 21st century, Summers explained, the neutral interest rate had fallen below zero. Which is to say: Capitalists’ preference for saving had grown so intense, even 0 percent interest rates could not deliver healthy growth.
But Summers’s most important heresy may have been this: If inadequate demand could trigger a sustained, self-reinforcing decline in investment, then the costs of understimulating the economy were far higher than Friedman had realized. Allowing a demand gap to persist wouldn’t just delay the restoration of the economy’s long-term productive capacity, but permanently lower that capacity. As Summers put the point, “lack of demand creates its own lack of supply.
In response, Powell’s Fed embraced a more dovish approach to monetary policy. Now, the central bank would wait until inflation ran above target for a sustained period before deciding that the economy had reached full employment. In a 2018 paper for the Brookings Institute, Summers had encouraged the Fed to revise its framework even more radically.
Summers’s economic commentary remained sharply progressive throughout 2020. In the spring, he and MIT economist Anna Stansbury released a paper that attributed rising inequality in the United States to a “decline in worker power.” In contemporaneous interviews, Summers suggested that Congress’s relief efforts had not gone far enough, calling for “a substantial increase in the funding available to states and localities.
The American Rescue Plan was a radical proposal in the guise of a modest one. On the surface, Biden’s first legislative priority looked like a mere extension of Trump-era relief policy. In macroeconomic terms, however, the two laws were dramatically different propositions. When the CARES Act was passed, U.S. households had just seen their net worths plummet, entire sectors of the economy were on hiatus, and the unemployment rolls were expanding at an unprecedented rate.
As Summers had long lamented, the U.S. never caught up to its pre-2008 growth trajectory. To realize that lost potential, policymakers would need to push the economy to exceed its existing capacities. That the American Rescue Plan would do precisely this was a feature not a bug. Further, by pushing labor demand to its breaking point, the bill would redress the decline in worker bargaining power that Summers had also bemoaned.
To Jason Furman, the former Obama administration official, the left’s indictment of Summers fails on all counts. “There’s a difference between heating the economy one log at a time and throwing all of the logs on the fire at the same time,” Furman said. “Everyone agreed that the economy needed fiscal support. But when you take the spending in the legislation that passed in December 2020 together with the legislation that passed last March, that added up to $2.8 trillion.