Summers speaks: in an exclusive interview, the Harvard professor takes on the subprime crisis, moral hazard, and Alan Greenspan's inflation forecast.

• Author: Summers, Lawrence H.
• Position: Dialogue with Lawrence H. Summers - Interview

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 of national security and foreign policy, with magazines and think tanks offering the means 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 inside club?

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 the world economy that it once did. Everybody remarks that of the G7 countries, three already use the same currency and most will not be among the world's five largest economies a generation from now. We worked very hard at broadening the structure during my time at Treasury. We had a "proliferate-the-fora" approach to involving other countries with the APEC and Latin American Finance Ministers meetings, the New Arrangement to Borrow, and the various G22, G33, and ultimately G20 groups. The dialogue does seem to be in better shape because of those efforts, but the new fora don't have quite the prestige or influence of the G7 in its heyday. It was the right place to start, although some alternative group will probably be important for the future.

The second problem in the coordination process is much less discussed, and it's less a problem than an aspect of the situation. The central banks have become much more independent than they were in the 1980s, and the fact that they 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 the bifurcation 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 the whole a good thing because of the credibility and disinflationary benefits it has brought, but it has also complicated the 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 might sensibly 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 and inflation have been significantly lower. To some extent, a less-robust coordination process is like observing that surgeons have had less to do. That may mean fewer interesting articles 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 decade or so. In 1997, I said in Davos that the main thing we have to fear is lack of fear itself. The line had been sufficiently forgotten that I used it again in the Financial Times this past 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 trick though is remembering that complacency is really an extreme manifestation of confidence, which is a good thing. I am not one who shares as fully as others the obsession 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, and therefore 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 bail out 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...