When Lawrence Summers criticized the Biden’s administration’s new economic policies in recent weeks as being the least responsible in 40 years, you might have expected the warning to jolt Democrats. Mr. Summers, after all, was formerly the U.S. Treasury Secretary under President Bill Clinton, the president of Harvard University and the economic adviser personally tapped by Barack Obama to help him navigate the financial crisis of 2008-09.
Instead, Mr. Summers was largely dismissed by his fellow Democrats. Progressives shouted him down on Twitter after he warned that the new administration’s $1.9 trillion economic rescue program could overstimulate the economy and spark inflation. Then Mr. Biden one-upped the stimulus program with a new $2 trillion spending plan for infrastructure and other projects. “It’s big, yes,” Mr. Biden said. “It’s bold, yes.”
“ The Democratic Party’s resistance to Mr. Summers’s call for moderation is a sign that a torch is passing in economic thought and policy. ”
Behind the drama, the party’s resistance to Mr. Summers’s call for moderation is a sign that a torch is passing in economic thought and economic policy. Exiting the stage after a long run in power is a group of accomplished centrist economists who came of age during an inflation spiral in the 1970s and governed from the 1990s to the 2010s, with a mixed record of success and failure.
The last among them in power is Janet Yellen, the Treasury Secretary, who has embraced the new “go big” thinking of the moment. For Ms. Yellen, who is preternaturally cautious, the challenge is to serve as a bridge between an older risk-averse thinking and ambitious new ideas. “There are a lot of ways in which I think our understanding of the economy has shifted,” Ms. Yellen told The Wall Street Journal in March.
The defining view of her cohort—sometimes known as New Keynesians—was that the government could help to tame recessions and unemployment, but policy makers also needed to guard against excessive inflation, large budget deficits and the government’s own limitations as a force for economic good. The New Keynesians were chastened by the harsh lessons of the 1970s and early 1980s, which produced double-digit inflation and double-digit unemployment. They sought a middle ground between free markets and unwieldy government activism.
Their accomplishments were real. They descended on Washington in the 1990s under President Bill Clinton and presided over an economic boom and the country’s last experience with a federal budget surplus. In the 2000s, they helped to prevent another Great Depression. But they also opened the doors to free trade, which damaged many American communities, and they had their hands on the levers of government during damaging tech-stock and housing bubbles in the 1990s and 2000s and a slow expansion in the 2010s.
Many were educated at elite Northeast universities, including the Massachusetts Institute of Technology, Yale and Harvard. Most were Democrats, like Mr. Summers and Ms. Yellen, who between them attended or taught at all three of those schools. They also included Republicans such as Ben Bernanke, who worked for George W. Bush and chaired the Fed for most of Barack Obama’s presidency; Gregory Mankiw, who served as chairman of Mr. Bush’s Council of Economic Advisers; and John Taylor, a Treasury official for Mr. Bush. “The New Keynesians are modest about what economic policy can accomplish,” Mr. Mankiw says.
Aging and working largely from think tanks and academia, the older New Keynesians are now giving way to more progressive thinking on the left and a reordering of priorities on the right. The new economic guard on the left hasn’t seen inflation in 50 years and doesn’t worry much about it. With interest rates low, it doesn’t worry much about budget deficits either. The fading of these concerns has opened the floodgates to expansive new government spending programs. Meanwhile, economists on the right, who have traditionally embraced free markets and small government, are searching for policies that might appeal to new, more populist, nationalist, blue-collar and antitrade constituencies in the Republican Party.
What is ironic and somewhat confusing about the passing of the economic torch now taking place in Washington is that Mr. Summers himself helped to start it. During the slow recovery that took place after the last financial crisis, Mr. Summers said that the economy was suffering from “secular stagnation,” a long period of weak demand that called for bold government action to reverse it. Persistently low inflation and low interest rates, he argued, made it possible to fund aggressive government spending cheaply.
For his part, Mr. Summers doesn’t consider himself a New Keynesian. Its line of thought, he says, has never been focused enough on long-run spending and investment trends. As a result, he was calling for a large government infrastructure program before much of the rest of Washington.
The current problem, he says, is that the $1.9 trillion Covid stimulus program overdid it in the short-term and spent in the wrong areas, sending relief checks to households rather than focusing on infrastructure programs like bridge-building or rural internet wiring. Secular stagnation, he says, doesn’t mean a policy maker can pour any amount of money into the economy, anywhere and at any speed. The large Covid relief plan, he says, risks reviving the very 1970s problems that shaped New Keynesian thinking and that Washington has come to believe it can now ignore. “The laws of economic arithmetic still apply,” he said in an interview.
To explain why aggressive government action does not pose a serious risk, some economists on the left have invoked Modern Monetary Theory, the idea that there is no constraint on the Fed or on government borrowing unless inflation clearly reemerges. MMT, as it is called, comes from outside the elite Ivy League schools that educated the New Keynesians. Its main advocate, Stephanie Kelton, is a professor at Stony Brook University on Long Island and earned her Ph.D at Manhattan’s New School for Social Research.
“ The new approach to the federal government’s role in the economy is grounded in what hasn’t happened over the past 20 years. ”
More than any academic theory, the new approach to the federal government’s role in the economy is grounded in what hasn’t happened over the past 20 years. The Federal Reserve has twice pushed short-term interest rates to near zero and pumped trillions of dollars into the financial system through bond purchase programs (sometimes called quantitative easing). In the past, such policies have been associated with an upward spiral in consumer prices—but not this time. Since the Fed created its official 2% inflation target in 2012, actual measures of consumer prices have run nearly a half percentage point below that threshold. Mr. Biden’s Council of Economic Advisers expects inflation to pick up in the months ahead and then to fade, it recently said in an online posting.
Large budget deficits also haven’t led to the negative repercussions that economic textbooks warn about. In theory, large additions to government debt would push up interest rates. The idea is that the government would have to promise investors an ever-higher return to persuade them to keep buying more and more of its debt. That would increase the government’s borrowing costs and crowd out private investment.
“ Private sector borrowing hasn’t been crowded out by government largess; in fact, private borrowing is booming. ”
Yet even though the federal government has increased its public debt load by nearly $5 trillion since the beginning of 2020, the interest cost on 10-year Treasury notes is lower by about 0.2 percentage points now, at 1.6%, than it was then. Private sector borrowing hasn’t been crowded out by government largess; in fact, private borrowing is booming.
Inflation, it turned out, was held down by competition from other countries in a more global economy and also by the slow recovery from the 2007-09 recession. Interest rates were held down in part because the global appetite for U.S. Treasury bonds runs so deep that people kept buying them even when the rates were very low.
The far-reaching economic agenda of today’s Democrats is driven in part by a sense that they were too focused on reducing budget deficits after the 2007-09 recession, which worked to their political disadvantage by holding back the recovery during the Obama administration. When Republicans were in power, they cut taxes and allowed deficits to grow. “Did you hear them complain [about budget deficits] when they passed close to a $2 trillion Trump tax cut?” Mr. Biden said in a news conference this month.
His inclination this time is to go big and to deal with any economic problems that result only if they actually materialize.
Write to Jon Hilsenrath at firstname.lastname@example.org
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