Jason Furman and Lawrence Summers are prominent Democratic-leaning academic economists, but not among those whose names have been put forward for prominent economic policy positions in a Biden administration--which leaves them free to be a little iconoclastic. Yesterday, they presented a "Discussion Draft" of "A Reconsideration of Fiscal Policy in the Era of Low Interest Rates" in an online event hosted by the Hutchins Center on Fiscal & Monetary Policy and the Peterson Institute for International Economics. Video and slides from of their presentation together with discussants are available here. Furman and Summers have been ruminating along these lines for some time: for another example, see their essay "Who’s Afraid of Budget Deficits? How Washington Should End Its Debt Obsession" in the March/April 2019 issue of Foreign Affairs.
Furman and Summers begin by noting that not only have interests rates been very low for more than a decade, but that according to the forecasts embedded in financial market actions (like the willingness to investors to put their money in long-term bonds that pay a low interest rates for decades into the future), interest rates seem likely to remain low for years or decades into the future. Here's, I'll list three main implications they draw for fiscal policy, and offer some thoughts about each one.
Implication 1: Active Use of Fiscal Policy is Essential in Order to Maximize Employment and Maintain Financial Stability in the Current Low Interest Rate World
The basic idea here is that with interest rates already very low, the Federal Reserve is not going to be able to respond to recessions by cutting interest rates by, say, 5-6 percentage points to stimulate demand. Even if the Fed was to move its benchmark policy interest rate slightly into the negative range by a few tenths of a percent, as some other central banks around the world have done, making those rates negative by several percentage points seems like a policy with risks of its own for financial stability.
Perhaps the main policy challenge here is that fiscal policy has traditionally been somewhat slow to adjust: that is, the economy slows down, Congress starts holding hearings, the economy is still slow, Congress passes a bill, the economy is still slow, the bill begins to take effect, the economy is (maybe) still slow, and the full effects of the stimulus bill percolate through the economy. Is there a way to speed the process?
History has taught that it's hard for the government to have a bunch of "shovel-ready" projects on hand, just ready and waiting to ramp up if the economy tips into recession. Thus, a lot of the more recent thinking involves considering spending bills that would be triggered--perhaps only in specific areas or regions--by an indicator like an ongoing rise for several months in the unemployment rate.
Implication 2: Lower Interest Rates Necessitate New Measures of a Country’s Fiscal Situation
When it comes to debt, a key practical issue is not the size of the debt itself, but the size of the payments you need to make. When buying a house, for example, you worry about the size of the monthly payments in comparison to your income, not the total debt. Similar logic suggests that in a global economy with low interest rates, a government can take on a higher level of debt. Summers and Furman suggest that rather than focusing on the size of the government debt, the appropriate goal should be to look at federal debt service payments (specifically, they recommend "limiting real interest payments to comfortably below about 2 percent of GDP ideally measured in the economically meaningful sense of net interest less remittances from the Federal Reserve and interest on Federal financial assets").
The general direction of this argument seems clearly correct: that is, one should worry less about a given level of debt when interest rates are lower. As the authors emphasize, long-term economic forecasts come with a heavy dose of uncertainty. They emphasize that if debt payments start rising, policy steps can be taken then.
But debt problems often don't evolve in a linear way, offering space to politicians for timely interventions before they go bad. As Rudiger Dornbusch used to say, in what I have dubbed the Hemingway Law of Motion: ""The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought." The current system for marketing federal debt, for example, is showing cracks. Another concern the authors do not discuss in any detail is that US government borrowing relies on inflows of foreign capital, because of of the low US savings rates. By contrast, government borrowing in Japan, say, can draw on Japan's high domestic savings rate. Thus, a recommendation for higher US borrowing is also a recommendation for higher US reliance on inflows of foreign capital from higher-saving countries, which will also imply generally rising debt from the US economy to foreign investors and generally higher US trade deficits (as the US consumes more domestically, financed by inflows of foreign capital). There would be an emerging pattern of global imbalances with risks of its own.
Implication 3: The Scope and Need for Public Investment Has Greatly Expanded
Furman and Summers offer an intuitively useful example of potholes in roads. If the potholes remain unfixed, they will get worse in the future and thus impose steadily rising social costs on drivers of vehicles. They write: "Put another way, it is better to fill potholes today than to wait and fill them at a cost that grows faster than the interest rate, which is currently around zero in real terms." What are some other "potholes" that it might be better to fix sooner rather than later?
The political economy danger here, of course, lies in offering politicians a blank check. With just a bit of rhetorical ingenuity, pretty much every government spending program can be re-conceptualized as an "investment." The authors write:
The above points depend heavily on what the additional debt is used for. If it is used to fund effective public programs with high rates of return, like research, infrastructure, education and investments and support for children, it is very likely to have benefits far greater than the costs of any additional debt accumulation. Wasteful and poorly designed spending programs or tax cuts, however, are not justified by this logic.
Even in some of these categories, Furman and Summers offer some cautions. For example, when it comes to infrastructure improves, an ongoing political challenge is to make sure the money is spent where it have the biggest payoff, not just spread around among Congressional districts in a way that ends up with beautiful and drastically underused rural highways or "bridges to nowhere" projects. Thus, it's important that users of roads and local governments spending local taxes have some skin in the game when it comes to local infrastructure improvements, and they aren't just spending what feels like free federal money.
As a bottom line, Furman and Summers suggest that their arguments would justify "[a]dditional investments of about 1 percent of GDP," which would be roughly $200 billion per year. This of course seems like an invitation to think about how you would spend this money. While I've got nothing against fixing physical potholes, my own preferences here would instead focus on human capital and technology.
For example, I'm not a big fan of universal pre-K programs: they cost a lot, and the recent evidence on such programs often shows short-term effects that fade over time (for example, here and here), although it still seems worth thinking about how to fund such programs for children from disadvantaged families. However, there does seem to me promising evidence on even earlier interventions for children: for example, the value of pre-natal care and nutrition, interventions aimed at families with children under the age of 2. Indeed, some economists have gone so far as to argue that redistributing spending from pre-K to policies aimed at younger children could be a net gain.
I would also spend a chunk of the money on a substantial rise in support for community colleges and apprenticeships. We seem to me to be in a time when employers have a strong demand for workers with particular skills, but those same employers have become more hesitant to do the training themselves--perhaps because they fear that most promising of these trained employees will leave for other jobs, or perhaps because they fear they they have become less able to fire those who do not complete the training successfully. In either case, the ladders of opportunity for getting into good career-oriented jobs have become frayed for many young and young-ish adults, and programs that match employers with public-sector training in the actual skills those employers need seem one way to reduce this problem.
Finally, it's a long-standing lament for me that the US economy underinvests in research and development, by which I would include not just basic research, but also the ability of communities to create self-sustaining centers where research and new companies and jobs combine in a virtuous circle. There's a strong case to be made that the US should phase in an increase in research and development spending of 50% or more, which can be done with a variety of tools including direct government support, tax incentives for industry, and encouragement for corporate labs. In addition, it would then be useful to have a process for spreading the effects of this technology across the US, rather than having it concentrated in a few cities. There are several fairly detailed proposals in which the federal government might set up a process in which medium-sized cities across the country that have university ties and a reasonable tech base in place could bid to become both reseach and economic centers for these new investments in technology.
I'm probably more worried about the current trajectory of US borrowing than Furman and Summers (for example, here and here). But it also seems true to me that, without any conscious decision, the role of federal spending has shifted quite dramatically: back in 1960 for example, 26% of federal spending was payments to individuals, in 2020, 70% of federal spending was payments to individuals. I like the idea of some federal programs focused on longer-term social gains, and this period of low interest rates seems like an opportunity to let this agenda have some air.