Former Treasury secretary Lawrence Summers sees a “real risk” of stagflation in the U.S. economy and believes the Federal Reserve committed a mistake by not recognizing inflation earlier on.
“I think it’s a real risk,” Summers replied. “Given where inflation is right now and given the downward pressures on the economy, I certainly think stagflation is a meaningful risk right now, and it’s probably a risk that’s underpriced in the markets.”
Regarding inflation, Summers insists that the Federal Reserve made a “big mistake” in not recognizing the threat of inflation back in 2021. The Fed remained stuck with that error “for much too long.” The central bank then “compounded that error” by not acting on the SVB crisis “soon enough,” allowing it to become a “broad systemic problem.”
Both inflation and SVB are two big problems “that got missed.” If the Fed had dealt with inflation earlier on, there wouldn’t have been a “dramatic spike” in interest rates that eventually led to the difficulties faced at SVB, he said.
Summers is unsure how high the Fed will have to raise interest rates to tame inflation and for how long it will have to keep rates at that elevated level. However, Summers thinks the economy is a “large part of the way through” the necessary tightening.
“If there were not a credit crunch and a banking set of issues, I would feel that the Fed needed to engage in three, perhaps a little more than that, more tightenings” he said.
Stagflation Risk
In an April 10 article in Financial Times, El-Erian predicted that the odds of a recession and stagflation afflicting the U.S. economy are now higher following a series of bank collapses in March.At the same time, many Americans have moved money away from bank deposits into market funds that offer higher yields.
“Instead, red has become a flashing yellow due to the slower-moving economic contagion whose main transmission channel, that of curtailed credit extension to the economy, increases the risk not just of recession but also of stagflation.”
“Price pressures remain relatively high, with the core Consumer Price Index (CPI) rising 5.5 percent year over year in February and services inflation still accelerating,” according to the investment bank.
Recession Predictions
The Federal Open Market Committee’s (FOMC) minutes from the March policy meeting state that staff at the central bank are expecting a “mild recession” later this year following the fallout of the banking turmoil. A recovery is predicted to take two years.The Conference Board’s Leading Economic Index (LEI) fell to its lowest level since November 2020 in March.