Larry Summers was right about inflation. Let’s hope his recession predictions are wrong.
For much of the past year, Summers was a lone voice sounding the alarm about the potential downsides of Biden’s U.S. bailout. His contrarian view: The $1.9 trillion spending program was over the top, especially with Fed Chairman Jerome Powell keeping interest rates near zero since the start of the crisis. pandemic.
“There is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recessionary levels will trigger inflationary pressures of the kind we haven’t seen in a generation,” he said. he wrote in a February 4, 2021 column in The Washington Post.
At the time, most of the economic establishment said his warning was too severe. The engaged citizen in me loved Biden’s aggressive approach to pandemic economics and Powell’s handling of the crisis.
Now, listening to Summers a year later, I think, yeah, he nailed it — for the most part.
When Democrats pushed the US bailout to Congress in March 2021, inflation was below the Fed’s 2% target. But by the summer, consumer prices had increased by 5% compared to the previous year; Last month, inflation hit 8.5%, the highest since 1981, the Labor Department said Tuesday.
Powell, believing the price spike would subside as the pandemic subsides, was slow to change course. As a result, inflation turned from benign to malignant, a serious threat to the economy that increased the chances of a recession unless the Fed plays its cards right.
Summers, 67, has been in high demand as the media invades the inflation story. In my interview and others, including recently with Ezra Klein of the New York Times and John Cassidy of the New Yorker, he laid out his outlook for the economy and took the Fed to task.
A former chief economist at the World Bank, Obama’s top economic adviser, a former president of Harvard: Summers is perhaps more qualified than anyone to serve as the de facto shadow chairman of the Fed. He is a center Democrat. Many members of the party’s progressive wing are suspicious of him because of his work with big banks and hedge funds, and his criticism of Biden’s stimulus spending.
While giving Summers credit for his foresight, remember that the cost of living has risen sharply, in part due to factors that neither he nor the Fed could have foreseen. The Delta and Omicron surges caused global economic havoc, as did Russia’s invasion of Ukraine and the sanctions imposed by the West in response. Without these factors, inflation probably wouldn’t be the front-page problem it is today.
So where do we go from here?
Like other economists, Summers saw positive news in the Consumer Price Index report for March, which was released on Tuesday. Most notably, price increases excluding the volatile food and energy categories slowed from February. With the current drop in energy costs, the past month may have marked the peak of this inflation spike, he said.
But hold the high fives. Inflation still has a long way to go to reach the Fed’s comfort level.
“It’s likely that the annualized CPI will decline from the 8.5% level,” Summers said. “It’s very different from getting inflation under control.”
Which means inflation is going to hang around like a rude guest at the party.
“These issues didn’t arise in a week or a month,” Summers said. “They won’t be resolved in a week or a month.”
To get inflation under control, Summers thinks borrowing costs will have to rise much more than the Fed has announced.
In its latest projections, the median estimate from central bank policymakers puts the benchmark federal funds rate at 2.8% by the end of next year. The rate is currently at 0.5%, following a quarter-point increase last month, the Fed’s first since 2018.
Summers thinks a federal funds rate of up to 5% will be needed to get real—that is, inflation-adjusted—rates well above zero. Only then will the cost of borrowing money be high enough to chill the economy.
This degree of credit crunch is hard to achieve without going too far or too fast and inadvertently pushing the economy into a recession.
The cost of borrowing to buy a home has already risen dramatically, with the average rate on a 30-year fixed mortgage hitting 5% this week for the first time since 2011, according to Freddie Mac.
The housing market could be the canary in the coal mine for whether higher rates lead to a soft or hard landing for the economy.
Summers now says the odds of a slowdown are about two-thirds within two years.
I hope he is wrong this time.