Larry Summers Thinks Reducing Inflation Won’t Be Quick or Easy

Former Treasury Secretary Larry Summers makes remarks during a discussion on low-income developing countries at the annual IMF and World Bank Spring Meetings in Washington, on April 13, 2016. Mike Theiler/AFP via Getty Images

Rooting inflation out of the U.S. economy won’t be quick, and it won’t be easy for the Federal Reserve, according to former Treasury Secretary Larry Summers.

The Harvard economics professor told Fortune magazine that the central bank needs to do more to cool elevated inflation. But while a growing chorus of economists and market analysts fear that the Fed might overtighten, Summers said he’s more concerned about the institution backing off prematurely.

According to the September Summary of Economic Projections (pdf), officials anticipate the benchmark federal funds rate to rise to 4.4 percent by year-end and hit 4.6 percent at the end of 2023, up from the current range of 3 percent to 3.25 percent.

However, Summers believes that the better number is somewhere between 5 percent and 5.5 percent.

“Most of us have learned that [when] the doctor prescribes you a course of antibiotics and you stop taking the course when you feel better rather than when the course prescribed is over, your condition is likely to reoccur. And it’s likely to be more difficult to eradicate the next time because the bacteria have become more resistant,” he said.

Summers is worried that if the Fed doesn’t go far enough or it eases its tightening campaign, “inflationary expectations will become entrenched.”

‘Implausibly Optimistic’

In a Twitter thread last week, Summers described the Fed’s dot-plot as “implausibly optimistic.” He explained that he doesn’t anticipate the core Personal Consumption Expenditures (PCE) price index falling to 2 percent and unemployment peaking at 4.4 percent.

The Marriner S. Eccles Federal Reserve Board building on Mar. 16, 2022. Saul Loeb/AFP via Getty Images

“Their forecast would for me be the optimistic tail of the distribution,” he wrote. “Happy to bet anyone that we see six months of unemployment above 5 [percent] before we see six months of inflation below 2.5 [percent].”

Summers also recommended that the central bank “consider the idea of TMI” [too much information]. He questioned if hour-long press conferences addressing hypotheticals and the unforecastable with gyrating financial markets in the background keep the Fed’s credibility intact.

He has been a vocal critic of President Joe Biden’s pandemic-era stimulus and relief spending.

In a February 2021 op-ed in The Washington Post, Summers wrote that macroeconomic stimulus “will set up inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.”

“But given the commitments the Fed has made, administration officials’ dismissal of even the possibility of inflation, and the difficulties in mobilizing congressional support for tax increases or spending cuts, there is the risk of inflation expectations rising sharply,” he wrote.

In an April 2021 interview with the Financial Times, Summers reiterated his position, saying that the Democrats’ $1.9 trillion American Rescue Plan (ARP) would lead to “rising inflation and a ratcheting-up of inflation expectations.”

Overtightening or Pullback?

Is there any hint that the Fed might ease its quantitative tightening cycle? During a press conference after the meeting of the Federal Open Market Committee, Fed Chair Jerome Powell offered investors a modicum of hope, telling reporters that “at some point, it likely will become appropriate to slow the pace of increases.”

At the same time, multiple central bank officials noted that the Fed would need to raise rates and keep them there higher for longer until there’s sufficient evidence that inflation is coming down. Fed Vice Chair Lael Brainard said reviving price stability is the central bank’s chief objective, although she also discussed the risks of overtightening and pulling back too soon.

“The rapidity of the tightening cycle and its global nature, as well as the uncertainty around the pace at which the effects of tighter financial conditions are working their way through aggregate demand, create risks associated with overtightening,” Brainard told the Clearing House and Bank Policy Institute 2022 Annual Conference in New York earlier this month. “And if history is any guide, it is important to avoid the risk of pulling back too soon.”

According to the September CNBC Fed Survey of economists, fund managers, and strategists, Wall Street forecasts that the central bank will raise rates to a restrictive territory—using monetary policy tools to slow the money supply’s growth and decelerate the economy—and hold them there for an extended period. The outlook suggests the fed funds rate peaking at 4.3 percent in March 2023 and coming down to 3.2 percent in December 2024.

But the survey also revealed that there’s heightened concern that the Fed will overdo quantitative tightening and trigger a recession.

“I’m fearing they are on the cusp of going overboard with the aggressiveness of their tightening, both in terms of the size of the hikes along with [quantitative tightening] and the speed at which they are doing so,” Peter Boockvar, chief investment officer of Bleakley Financial Group, wrote in response to the survey.

The odds of a recession over the next 12 months stood at 52 percent, unchanged from the previous survey in July.