Former Treasury Secretary Lawrence Summers warned against excessive optimism about the US being able to quell inflation without an economic downturn, and reiterated that the Federal Reserve will likely need to raise interest rates further.
(Bloomberg) — Former Treasury Secretary Lawrence Summers warned against excessive optimism about the US being able to quell inflation without an economic downturn, and reiterated that the Federal Reserve will likely need to raise interest rates further.
“It’s a very narrow window to achieve that soft landing,” Summers said on Bloomberg Television’s Wall Street Week with David Westin. “There is no sign” at this point that this is a “2% inflation economy,” he said, adding that “the Fed is right to be data dependent” in setting its policy.
There’s about a one-in-three chance for each of three scenarios, Summers said: a soft landing, a “no landing, with inflation never really getting below 3%,” and a harder landing where the Fed’s cumulative rate hikes hit the economy.
“People need to be very careful about declaring victory — to be very careful about some assets, particularly in the stock market,” said Summers, a Harvard University professor and paid contributor to Bloomberg TV. “It may be priced a bit for perfection.”
Interest-rate futures suggest traders aren’t fully pricing in another 25 basis-point rate increase by year-end. Two-year Treasury yields dipped Wednesday morning, even after data showing a bigger-than-forecast rise in the core consumer price index, which strips out volatile food and energy costs. The core CPI rose 4.3% in August from a year before.
Read More: US Core CPI Picks Up, Keeping Another Fed Hike in Play This Year
“At this point, my best guess is that inflation is going to be a little strong and that they’re going to need to move again,” he said in reference to the Fed. “It’s certainly possible that they’ll have to move more than once,” he said, while noting that that wasn’t his prediction.
The former Treasury chief also cautioned against thinking that the Fed will automatically need to start lowering rates if inflation comes down. One school of thought has argued that if price gains slow, that will effectively mean a tighter Fed monetary setting, because real interest rates will be higher. That’s “too facile” a claim, he said.
Summers said the issue is that inflation now is largely a problem in the service sector. A slowing of price increases there isn’t “really going to have much of a contractionary impulse for spending,” he said.
“So I think that argument pointing towards policy automatically moving towards restriction is a bit overdone,” Summers said. He said he hoped that, in their updated projections due out next week, Fed policymakers aren’t “overly signaling that rates are going to come down” next year.
Fiscal Challenge
He also reiterated that insufficient attention is being paid by the Fed to the stimulative impulse to the economy from a widening fiscal deficit.
Fed Chair Jerome Powell “was not nearly as concerned as he should have been about the scale of fiscal stimulus in 2021. And I’d rather see him expressing more concern about the fiscal situation that we’re heading into,” Summers said.
Read More: US 10-Month Budget Gap Hits $1.68 Trillion on Record Interest
Summers also reiterated that it’s important to keep an eye on the talks between the United Auto Workers and carmakers over an increase in compensation. While this is an area “less dominant for the whole economy than it was a generation ago” it’s still “a big deal,” he said. And it may “set a template” more broadly, he added.
(Adds reference to auto industry labor talks, in final paragraph.)
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