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Larry Summers and the never-ending bubble economy

Lawrence Summers
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Lawrence Summers

When the recent McKinsey study on the effects of unconventional monetary policy challenged the idea that very low interest rates could provide much economic stimulus, the reasoning was pretty straight forward.

A "'rational expectations" investor who takes a longer-term view should regard today's ultra-low rates as temporary" and therefore won't change his investment plans in ways that boost asset prices or economic growth, according to the analysis.

The basic premise—that low rates are about to end any minute now—informs a lot of discussions around markets and economics today.

The budget deficit isn't a problem now—but it will be when interests rates rise. Bond prices are in a bubble and bond investors will lose a ton of money—when interest rates rise. The share price of home builders will fall rapidly—as interest rates climb.

There are a host of related concepts that you hear a lot. One is that the Fed is keeping rates "artificially low." Savers are being "starved" of interest income. The Fed should do a better job preparing the economy for its "exit strategy."

But what if all this is wrong?

I've argued before that I don't see any evidence that rates are "artificially" low. (I'm not even sure that it makes much sense to use the word "artificial" when talking about interest rates in our economy.) And I don't see any reason why interest rates should return to historically normal levels in the foreseeable future.

Paul Krugman, in his New York Times column and on his blog, points to a speech former White House economist Larry Summers recently gave to the International Monetary Fund that makes the point that we may be in a period of "secular stagnation"—a kind of long-term slump in which even ultra-low interest rates are too high to stimulate the economy to full employment and decent growth.

Here's how Krugman explains things:

And if Mr. Summers is right, everything respectable people have been saying about economic policy is wrong, and will keep being wrong for a long time.

Mr. Summers began with a point that should be obvious but is often missed: The financial crisis that started the Great Recession is now far behind us. Indeed, by most measures it ended more than four years ago. Yet our economy remains depressed.

He then made a related point: Before the crisis we had a huge housing and debt bubble. Yet even with this huge bubble boosting spending, the overall economy was only so-so — the job market was O.K. but not great, and the boom was never powerful enough to produce significant inflationary pressure.

Mr. Summers went on to draw a remarkable moral: We have, he suggested, an economy whose normal condition is one of inadequate demand—of at least mild depression—and which only gets anywhere close to full employment when it is being buoyed by bubbles.

You should probably go watch the video of Summers' speech.

This means that concerns about exit strategies, rising rates, and assets bubbles are not only misplaced. They're probably counter-productive. Low rates are very likely to be with us for a very long time.

—By CNBC's John Carney. Follow him on Twitter @Carney

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