THE MAGAZINE OF
INTERNATIONAL ECONOMIC POLICY
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Summers
Speaks
TIE: This is the twentieth anniversary of The International Economy magazine.
In some respects, this magazine really appeared in part because of some remarks
you made at one of the conferences we held back in the 1980s. You stood up
and commented on how there was a need for greater statecraft within the international economics community. Certainly statecraft existed then in the fields ofnational security and foreign policy, with magazines and think tanks offering themeans for discussion, but not enough in the field of international economic policy.
Summers: I do recall thinking that there was a space between the Henry Kissinger
kind of stuff—geopolitics and negotiations—and Martin Feldstein stuff—regressions and models. It seemed underfilled.

TIE: You’ve been involved as a policymaker in the G7 policy coordination
process. How do you feel about where things are going today, and what changes
need to be made? Should the system be restructured? Is it impossible to have G7
cooperation given so many new countries that aren’t normally part of the insideclub?
Summers: We have two main challenges in terms of the coordination process.
First, the G7 doesn’t have the legitimacy or primacy as a steering group for theworld economy that it once did. Everybody remarks that of the G7 countries, threealready use the same currency and most will not be among the world’s five largest
Lawrence H. Summers has served as President of Harvard University,
2001–06; U.S. Treasury Secretary, 1999–2001; and World Bank Chief
Economist, 1991–93. He is now Charles W. Eliot University Professor at
Harvard and part-time managing director with D.E. Shaw Group, an investment
and technology development firm.
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Lawrence H. Summers

In an exclusive
interview, theHarvard professor
takes on the subprime
crisis, moral hazard,
and Alan Greenspan’s
inflation forecast.

SUMMERS

economies a generation from now. We worked very hardat broadening the structure during my time at Treasury. We
had a “proliferate-the-fora” approach to involving othercountries with the APEC and Latin American Finance
Ministers meetings, the New Arrangement to Borrow, andthe various G22, G33, and ultimately G20 groups. The dialogue does seem to be in better shape because of thoseefforts, but the new fora don’t have quite the prestige or
influence of the G7 in its heyday. It was the right place tostart, although some alternative group will probably be
important for the future.
The second problem in the coordination process ismuch less discussed, and it’s less a problem than an aspectof the situation. The central banks have become much more
independent than they were in the 1980s, and the fact thatthey are is taken much more as a given. The European
Central Bank doesn’t quite have a political master, and the
U.S. Federal Reserve and the Bank of England are much
more independent, while the Bank of Japan is somewhat
more independent. The concept of seven or twenty countries negotiating is less feasible than it once was with thebifurcation of power within countries. You can’t really separate exchange rates from monetary policy. So what exactly
is it you’re coordinating? Independence has been on thewhole a good thing because of the credibility and disinflationary benefits it has brought, but it has also complicatedthe coordinating process.
Judging not by the state of the process but by the outcomes, the global economy has grown more rapidly than we
could reasonably have expected or any forecast we mightsensibly have made twenty years ago when The
International Economy magazine was launched. The U.S.
economy has grown far more rapidly than we could reasonably have expected, and the degrees of cyclicality andinflation have been significantly lower. To some extent, aless-robust coordination process is like observing that surgeons have had less to do. That may mean fewer interestingarticles for Surgery Today magazine, but it also represents
a great deal of progress for the world.

TIE: Do you think because of all this prosperity and lack of
cyclicality, we’ve become complacent? Maybe we won’t
be as prepared this time?
Summers: Perhaps. I recycle a particular line every decadeor so. In 1997, I said in Davos that the main thing we haveto fear is lack of fear itself. The line had been sufficiently
forgotten that I used it again in the Financial Times thispast winter. There is a tendency toward complacency. And
as we have seen in recent months yet again, complacency
can easily become a self-denying prophecy if it leads to
imprudent borrowing, lending, and spending decisions.

The current arrangements where
the Fed is closely involved with big
banks but much less involved
with other institutions could create somepressures for a more corporatist,
Japanese-style approach than
I would be comfortable with.
The trick though is remembering that complacency isreally an extreme manifestation of confidence, which is agood thing. I am not one who shares as fully as others theobsession with moral hazard. The mirror image of moral
hazard is confidence, and we generally have an environment where there is confidence that contagion will be contained, that bank runs won’t be allowed to spread, andtherefore people can take risks they might not have otherwise. This is a major stabilizing factor for the global economy and probably also reduces the need for extremely
expensive bailouts.

TIE: Good point. In fact, you could argue that blustering
about moral hazard and then reversing yourself to bailout a troubled bank, like Bank of England Governor
Mervyn King with the firm Northern Rock, discredit moral
hazard.
Summers: It’s all very well to grumble about moral hazard, but five million American families own their own
homes thanks to a more sophisticated mortgage market.
There are plenty of predatory abuses that we should correct, but we need to be careful about succumbing to a sadomasochistic “We need pain or we’ll become complacent”
sort of world view.

TIE: Moral hazard is not something easily defined,
because where is a fine line when it becomes an act being
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European Embarrassment“At an international meeting a decade ago, I inquired
innocently, “Could the Europeans here explain tome what happens if a bank in Spain gets into serious trouble? What are the respective responsibilities of the
Spanish supervision authorities, the Spanish central bank, the
ECB, and Brussels?” What followed was a brief embarrassed
silence in which the Europeans looked at each other, then achaotic argument among the Europeans, which ended without resolution but only a sense that they didn’t want to air theirlinen in front of the rest of us. So I was left with the sense
that, as so often happens in public life, harmony had been purchased at the expense of ambiguity. I think we’re seeing someof the consequences of that ambiguity.”—L. Summers

geared to systemic or to special privilege? It’s very hard
to tell until after the fact.
Summers: Here’s a question. What surprised you about former Federal Reserve Chairman Alan Greenspan’s new book,
The Age of Turbulence?

TIE: We were surprised that he actually wrote the book.
For someone like Greenspan, our view was that it’s betterto be always writing the book but never finishing it. Now
everybody can choose sides. We’re surprised at how hard
it’s been hit. As smart as he is politically, he didn’t seem toanticipate that he was vulnerable on the issue of the subprime housing bubble. We think he anticipated some of thecriticism and created a clever diversion by criticizing theRepublican Party for their lack of discipline on spending
and deficits. That diversion only worked briefly, however.
We’re also amazed that Greenspan hasn’t used a more
effective defense strategy over his responsibility for creating the housing bubble. Look at the period when the Fed
reduced interest rates to one percent. The United States
appeared to be following the same disinflationary path ofJapan. The Fed had to make some very tough decisions
with unintended consequences, one of which was a housing bubble. This bubble, frankly, is going to be very painful
to a lot of people, but that’s nothing like having a lost
decade like the Japanese did, from which they are still trying to recover. Greenspan knew the United States had toget ahead of that train, and he acted accordingly. That’s
the case he should be making. The nature of this financial
system means there are no simple moves. Everything has
a tradeoff.
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In addition, Greenspan gets absolutely no credit
for his insight in the late 1990s that increases in productivity would allow unemployment to drop without
stoking inflation. That insight probably gave this country a couple trillion dollars of additional wealth.
What do you make of Greenspan’s forecast of
inflationary danger by the year 2030?
Summers: I am somewhat more optimistic than myfriend Alan Greenspan about the prospects for inflation
over the next fifty years. The first edition of Paul
Samuelson’s textbook in 1947 showed a graph of theprice level, not a graph of the rate of inflation, because
the price level went up and down. The world experienced a terrible and quite universal episode of inflationin the 1970s and 1980s. But I look at the full variety ofcountries, including countries such as Brazil with very
substantially populist governments that have maintained reasonably durable commitments to low inflation now in a variety of political environments, and I
wonder whether the world’s fairly disastrous abuse of fiatmoney in the post-Bretton Woods period may not prove to
be a somewhat more historically isolated episode than Alanbelieves. Conversely, I see a greater risk that combinationsof bad luck and bad financial policy will lead to significant
parts of the world having a disastrous and protracted recession of the kind Japan suffered during the 1990s.

TIE: How do you size up Fed Chairman Ben Bernanke’s firsthandling of a crisis? Of course it’s not over, but his coming
in with a fifty-basis-point move on the discount rate brings
up the whole question of his coming to terms with theGreenspan “put.” To what extent is there now a Bernanke“put”?
Summers: It’s premature to make any definitive judgements.
Certainly many of the worst sinners in the subprime lending
business have gone bankrupt, and many more have lost large
amounts of value. Those who mis-assessed the risks associated with a whole variety of securities have suffered very
substantially.
There’s no question that the Fed has been successful inadding confidence in a very difficult situation. In doing that,
the Fed has probably created some expectation that in futuredifficult situations it will add confidence. That may lead tosome increased risk-taking, but also to increased confidence
and stability the next time there’s an adverse shock.
This crisis leaves us with a very big question about what
the tools are for regulating and providing finance when theequivalent of a bank run takes place with respect to a nonbank entity. That question is not satisfactorily resolved in
the regulatory system of any country.

SUMMERS

TIE: Perhaps the financial system isn’t quite sure where
the safety net is, so these off-balance-sheet entities
develop with too much confidence. Can you clarify thisissue, taking into account your points about moral hazard?
Summers: I don’t think we have a single safety net. There’s
a constellation of policies; liquidity support to protect againstbank runs guarantees to insure investors in certain institutions. Yet the need for regulation is inherently part of any
modern financial system. Regulation and liquidity support
need to be properly balanced against each other, and we do
not have complete clarity about how that balance is to takeplace in the United States right now. There is certainly someindication that some institutions are systemically importantenough to merit a financial response, yet these institutions
are not significantly regulated before problems become
apparent.
There’s also considerable evidence that regulation withheavy emphasis on mark-to-market pricing can easily induce
pro-cyclicality. And there is the concern about whether satisfactory tools exist for providing liquidity as distinct fromguarantees when the problems lie in non-bank institutions.
One of the important risks in the current system is that it
creates some incentives toward turning major banks into
public utilities which are asked to cooperate with the Fed in
responding to broader problems in the financial system. One
needs to stay very far away as a general matter from encouraging policy lending. The current arrangements where the
Fed is closely involved with big banks but much lessinvolved with other institutions could create some pressures
for a more corporatist, Japanese-style approach than I would
be comfortable with.

TIE: How worried are you about the fact that in Europe,
there seems to be a separation between the roles of monetary policy and the roles of bank supervision and bankregulation?
Summers: I am worried but not surprised. At an international meeting a decade ago, I inquired innocently, “Could
the Europeans here explain to me what happens if a bankin Spain gets into serious trouble? What are the respective
responsibilities of the Spanish supervision authorities, theSpanish central bank, the ECB, and Brussels?” What followed was a brief embarrassed silence in which theEuropeans looked at each other, then a chaotic argument
among the Europeans, which ended without resolution but
only a sense that they didn’t want to air their linen in frontof the rest of us. So I was left with the sense that, as so often
happens in public life, harmony had been purchased at theexpense of ambiguity. I think we’re seeing some of the consequences of that ambiguity.

TIE: We agree. Let us ask you something on a broader
topic. The industrialized world economy has benefited fromseveral decades of cheap commodity prices, including oil.
With this explosion in globalization as China and India continue to develop, we’re seeing commodity prices going
through the roof. The world’s excess saving economies—
including the oil producers—are in a situation that clearly
looks like it’s leading to tensions with the industrialized
world. They are establishing sovereign investment fundswith the desire to purchase hard assets. Do you see thisleading to an unraveling of the whole globalization model?
Summers: I’d offer several observations. First, there’s a consistent tendency to underestimate the impact of real interest
rates on commodity prices. When real interest rates are low,it always seems like a good idea to keep your commodity inthe ground and let it appreciate. So to an extent I think isunderestimated, commodity prices will tend to track the
behavior of real interest rates. We’ve had abnormally low
real interest rates in recent years. I wouldn’t be certain that
we will have a high commodity price environment forever.
To some extent, the move toward a more knowledge-based
economy has made commodity prices less central than they
once were to the overall economic performance of industrial countries.
The second observation is that the whole set of issues
surrounding sovereign wealth funds is going to require very
extensive attention. It is difficult to know just where thebright lines should be drawn, but it would be a great irony
and not a happy one if we were to see large-scale crossborder renationalizations over the next decade because sovereign wealth funds or central banks with large
accumulations of reserves chose to make direct investments
in hard assets with control rights rather than indirect portfolio investments. I don’t look forward to the day wheninternational diplomacy includes requests for tax breaks forthe companies in one country that are owned by the sovereign wealth fund of another country. On the one hand, it isa mistake to abuse the concept of “strategic” in order toprovide protection. But equally it’s a mistake to assume thatgovernments are just another investor if they’re investing
hundred of billions of dollars and if their broad geopoliticalinterests are not in harmony with the country in which
they’re investing.

TIE: China appears to be experiencing a bubble. Has thereever been a bubble that didn’t burst?
Summers: We only call it a bubble in history if it did burst.
For example, in the fall of 1996 when Alan Greenspan used
the term “irrational exuberance,” the Dow was in the 6,000s.
That was a declaration of a bubble that wasn’t. There was a
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quite high degree of confidence in many quarters thatthe dollar was a bubble deeper into the 1980s thanproved to be the case. Many observers expected somedeceleration in Asia to take place more quickly than it
did before the Asian financial crisis.
If you asked whether there ever been significant
prophecies of doom that didn’t come true, certainly there
have been people for twenty-five years now who havebeen very worried about very damaging hard landings
from the dollar, but whose fears have not materialized.
International monetary history records dozens of
instances of exchange rates that were held too fixed for
too long, with substantial adverse consequences at the
moment when the exchange rate had to let go. I amaware of no convincing example of a fixed exchange
rate that could have been maintained but that was instead
adjusted prematurely, and for which there were adverse
consequences. Looking at the tendency toward very
fixed exchange rates in many of the emerging market
countries, I worry that mistake will be made again,
though to be fair we have much more experience withcountries where the exchange rate should be devalued
than revalued.

TIE: Where do you see the situation with global imbalances going at this point?
Summers: The classic concern with respect to imbalances is that a situation develops where people are bothtrying to take money out of a country’s banks and trying
to sell its currency. And the central bank can’t both add
liquidity to help the banking system and the economy
and reduce liquidity to maintain currency stability. Thoseare the situations where imbalances become most serious. The United States is much closer to a situation ofthat kind now than it has been at many other moments ofconcern about imbalances.

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Summers: On trade, the lessons are pretty clear that
more open markets in the vast majority of cases contribute very strongly to better economic performance.
Nothing in the experience of the last decade suggests
otherwise to me. It is true that widening income inequality is becoming a central economic problem in the UnitedStates and to a lesser extent in the industrial world. And
that is going to require a much more energetic responsethan the standard adjustment assistance that tends toaccompany advocacy of free trade.
If the income distribution in the United States were
the same today as it was in 1979, the bottom 80 percentof the population would have about $670 billion more, orabout $8,000 per family. And the top one percent would
have about $670 billion less, or about $500,000 per family. Relative to numbers like that, a $3 billion tradeadjustment assistance program looks very small. We
need to think in a much more comprehensive way about
income distribution, the progressivity of taxation, theenforcement of tax laws, and the benefits of public
spending if we’re going to maintain broad support for
the legitimacy of the system including the ability tomaintain open markets.
With respect to global warming, it is very hard toknow which way it will move. In no other public policy
issue that I’ve been engaged in has the gap between the

In the fall of 1996 when
Alan Greenspan used the term
“irrational exuberance,” the Dow

TIE: We’re not sure though how many eurodollars andpounds are being pumped out there either.

was in the 6,000s. That was a

Summers: Right. To what extent this is an American
problem or a general problem or an English-speaking
country problem is not entirely clear.

declaration of a bubble that wasn’t.

TIE: How do you size up the free trade consensus in
the United States? And to what extent will global warming become a factor in trade discussions? The Germans
are talking about spending 800 billion euros over the
next thirty years on global warming. Will global warming efforts become a kind of a new industrial policy, thenext great stimulus of domestic demand?

rhetoric and the concrete action been as large. While
there is tremendously visionary rhetoric about the complete transformation of economies and the like, the reality is that all of the discussions of global warming haveto date resulted in only very small differences in patternsof energy use relative to business as usual. While Europe
is doing much better than the United States or other parts

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SUMMERS

I am somewhat more optimistic
than my friend Alan Greenspanabout the prospects for inflation
over the next fifty years.
of the world at meeting the kinds of targets embodied in
the Kyoto Protocol, that is largely because of events
involving de-emphasis on coal in England, Germany,and Russia which were driven primarily by domestic
factors rather than by global warming concerns.
The future for emissions reduction is much lessclear. If the European Union was not able to impose
penalties on countries that failed to meet budget deficit
targets, with all the history of comity and cooperationthat existed in Europe and all the direct control that governments have over their finances, it is going to be profoundly difficult to reach enforceable agreements.
Emissions are much harder to measure than budget
deficits and, because they depend upon overall economic
performance, are actually much less subject to public
control. While I have no doubt that the science is entirely
clear about the very large risks of unchecked accumulation of greenhouse gases, and while there is increasing
rhetorical and political commitment in many countries,
I think that the task of reaching viable international
agreements is a formidable one that many underestimate.
There is a strong tendency in political life to respondto political difficulty by simultaneously lengthening thehorizon and escalating the strength of the commitment.
When I hear politicians talk about reducing greenhousegases by 50 percent relative to benchmark by 2030 or
2050, I sense this tendency making itself felt. It would bemuch more impressive if meaningful actions were undertaken that would change patterns of energy use througheither taxes or regulatory instruments with measurable
impacts three or five or seven years from now.
There hasn’t been enough reflection yet on the interactions between the global warming issue and international trade. The point is frequently made in the UnitedStates that it is not fair for the United States to take onbinding commitments with respect to greenhouse gases
if other major countries do not take those commitments.

There’s certainly some force to that argument. But there
is a stronger related argument that if such commitments
are undertaken by the major industrial countries and notby other countries, there’s the prospect that they will nothave any effect on the overall level of greenhouse gas
emissions because the production of energy-intensive
goods will simply migrate to the countries that are notconstrained. When that happens, the targets will perhaps
be met from the industrial countries, but the reductionsin industrial country emissions will not represent reductions in total global emissions, so they will be ineffective.
The world has so much difficulty now enforcing codeson subsidies or measures of protection. How is it going
to undertake the formidable task of looking at the overall structure of energy economies and judging when there
are unfair subsidies?

TIE: Larry, maybe you were right all along years ago
when you were so criticized at the World Bank for yourviews on comparative advantage.
Summers: As has been the case at several points in mycareer, those thoughts could perhaps have been expressedin a more felicitous way.

TIE: One final question: Are you supporting a candidatein the Democratic primary? And how do you size up the
economic, trade, and financial positions of the threemajor Democratic candidates?
Summers: There’s a great deal that can be improved onin the economic policy of the last seven years. Moreneeds to be done to restore the kind of fiscal health that
we had in 2000. A more cooperative posture needs to betaken with respect to the rest of the world. The needs of
middle-class families have not been central in the setting of economic policy over the last seven years in theway they were during the Clinton years. And we’ve had
important shortfalls in a variety of public investmentareas despite all the increases in domestic spending. Can
it possibly make sense with the life sciences revolution
we’re having that there’s substantially less grant money
available for young biologists today that there was two
years ago? And if anyone thought that the failure to build
the levies in New Orleans was an isolated accident, thebridge collapse in Minneapolis should have convinced
them otherwise. We can do much better as a country, andthe differences between the Democratic candidates areprobably small compared to the differences between anyof them and the Republicans.
◆

TIE: Thank you very much.
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