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Summers Speaks on World Economic Issues

By Kristen Landino

Deputy Secretary of the U.S. Treasury and Institute Alumnus Lawrence H. Summers ’75 spoke on issues relating to the global economy in Bartos Theatre last Tuesday afternoon.

His speech was part of an ongoing series of public policy lectures sponsored by the Undergraduate Economics Association.

Summers’ talk focused on effective U.S. and foreign policy initiatives in times of financial crisis.

“The world economy cannot fly forever on a single American engine. Japan and Europe must contribute to growth as well,” Summers said.

Summers speaks on 90’s finances

Summers gave a brief synopsis of the U.S. response to the slowdown in Gross Domestic Product growth experienced during the recession of the early 90’s. Summers, who worked closely with President Bill Clinton on responding to this economic problem, cited deficit reduction as the major policy objective of Clinton during this period.

According to Summers, the Clinton administration’s policy helped to bring long term interest rates down, which spurred investment-led growth, resulting in a budget surplus by 1998.

Summers cited the advantages of a budget surplus, among them that it gives the government the opportunity to “reload the fiscal cannon.”

“The U.S. economy is doing very well now. The only thing we have to fear is the lack of fear itself. Complacency can be a self-denying prophecy if it leads to unrealistic expenditure plans, excessive capacity creation, inappropriate asset valuations, or misguided credit expansion and acceptance of leverage,” Summers said.

‘Moral hazard’ a risk for future

Summers also discussed the current financial crises occurring in emerging markets. He stated that the central problem in these situations is “money lent without a system that generates the capacity to pay.”

Summers also mentioned the issue of moral hazard as one of the primary challenges facing the Asian financial system in light of the current crisis. Moral hazard refers to the problem that firms are less careful with lending if they know the government will protect them in the event of major financial losses.

Summers next raised the issue of multiple equilibrium and discussed its repercussions. He mentioned the example of Korea, where private banks depleted their currency reserves and were forced to default on government loans. As a result, investor confidence failed and people withdrew their money, exacerbating the financial crisis.

Summers cited a couple of policy responses to this situation: to encourage these countries to restructure their financial systems in order to regain investor confidence.

A possible solution, according to Summers, is for the International Monetary Fund to provide liquidity by safeguarding people’s deposits, preventing the bank runs which result from the domino effect loss in investor confidence. He cited Korea, Thailand, and Brazil as examples of where this policy has worked.

To wrap up his talk, Summers discussed the two types types of exchange rate regimes used in current economic policy: floating and fixed. He also touched upon the advantages and disadvantages of dollarization in Latin American.