PILING ON

The IMF says Larry Summers is right—and Ben Bernanke is wrong—about economic stagnation

The biggest debate in the economics world—whether advanced economies like the United States or the European Union are doomed to stagnation—has pitted former US Treasury secretary Larry Summers against former Federal Reserve chairman Ben Bernanke. One Nobel prize-winning economist already has weighed in to take Summers’ side over Bernanke’s. Now, the IMF is piling on.

Summers has proposed “secular stagnation” (pdf) as the explanation for economic weakness since the 2008 recession: Private investment is falling because firms see slow population growth and innovation as a sign that future returns aren’t likely, creating a self-fulfilling prophecy of slow growth. His answer is more government investment—to jump-start demand, and the economy.

Bernanke, meanwhile, thinks recent slowdowns in private investment are merely a result of the recession’s economic hangover, and that the big, structural problem for advanced economies is a “global savings glut” that is forcing US interest rates lower than they otherwise would be—so in essence, blame Germany. In the former Fed chair’s view, better government policies on global capital flows and trade could solve this problem. Otherwise, efforts to keep interest rates low enough to maintain full employment will lead to more financial bubbles.

It can be hard to tell which case is right, since both manifest the same problem: Too much savings, not enough investment, and low growth. For the International Monetary Fund’s economists, the solution seems clear: Governments need to do more to stimulate demand.

Two chapters of the IMF’s World Economic Outlook, released today, deal with this question, one focusing on economic growth overall and one focusing on the fall in private investment. The reports conclude, first, that the reason for slower growth isn’t the lingering effects of the crisis but the pressure from slowing population growth and innovation; and second, that private investment is falling because companies don’t see enough demand from their customers, not because of diminished returns from low interest rates.

To be sure, the IMF—an multilateral organization overseeing global financial flows—isn’t likely to say that some of its member countries’ policies, particularly Germany’s beloved current account surplus or China’s more blatant currency manipulation efforts at the beginning of this century, are leading to financial imbalances and thus slow growth.

Only time (and further blogging) will tell: If Summers is right, slow growth and low interest rates will dominate the future unless major spending efforts come to bear, but Bernanke remains hopeful that trade and investment will return to balance internationally, allowing interest rates to rise.

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