On Wednesday, Harvard Kennedy School economist and former U.S. Treasury Secretary Lawrence H. Summers told members of the Council on Foreign Relations that he stands by his own recent warnings (a view that has both galvanized and divided economic opinion even among his fellow Democrats) that the Biden Administration’s $1.9 trillion stimulus plan, quickly following monetary easing by the U.S. Federal Reserve to support the economy’s recovery from covid-19, risks dangerously overheating the U.S. economy and tipping it into recession.
Speaking to members in a conversation moderated by Financial Times journalist Gillian Tett, Summers said his own inflation analysis–which he outlined in a provocative op-ed in the Washington Post in February–“isn’t very difficult.”
The U.S. economy is grappling with a “hole” as measured by lost (below trend) labor income on the order of $20-30 billion per month (and declining), perhaps amounting to $200-250 billion this year. Faced with that shortfall, the U.S. is providing $2.8 trillion in stimulus (or $250 billion per month), to be followed by more stimulus from the Fed, more stimulus from follow-up relief packages, as well as substantial passive stimulus coming to the economy both from the savings overhead of money that people couldn’t spend last year, and the effects of covid being gradually removed from the economy.
“It seemed to me [upon writing the February op-ed] that economics comes back to demand and supply, and we were providing demand well in excess of any plausible estimate of the economy’s ability to produce,” Summers said.
How hot to run
Tett pressed Summers on how he would respond to advisers within the Biden Administration who argue that massive stimulus is the only way to tackle income inequality and help disadvantaged segments of the population. He countered that while he is “all for running the economy as hot as is sustainable,” all evidence points to inflation being a terrible thing for poor people, and that while the primary beneficiaries of the massive asset bubbles created by excessive monetary stimulus are the most wealthy, the primary victims of large-scale labor shortages, inflation, and forced, uncontrolled upward movements in interest rates are poor people.
Summers questioned how the Biden Administration, or any serious economist for that matter, could both assert that the U.S. is now in an entirely and dramatically new social revolution of policy, but that no one should change any expectations about the inflation outlook.
“Last time we tried something like this, driven by progressives in the 1960’s, we attempted to have a Great Society and fight [the] Vietnam War at the same time,” he said. [But], “Fed(eral Reserve) rhetoric was much less bold, less expansionist.” Nonetheless, the consequence was a 1-handle on percent price increases in 1966, to a 6-handle in 1969, before the economy showed a single adverse supply shock. Today–granted, economists are divided in their theories as to what drives sustained inflationary spikes–there’s output gap theory, which is “flashing red;” there’s fiscal theory based around the consequences of deficits, which, too, is “flashing red;” and there’s monetary theory, which is also flashing red.
But Summers stopped short of saying that the Fed should move to raise rates sooner, or that it may have been (as Tett probed) a “mistake” for the central bank to have raised its inflation target above 2 percent.
“The Fed has traditionally acted and spoken in ways designed to pre-empt inflation fears,” he said. “Today the Fed speaks in a way that’s designed to pre-empt the idea that the Fed might have inflation fears. That’s a very different thing, and a thing that is likely to contribute to the development of an inflationary psychology.”
Alluding to the old saw (attributed to former Fed Chair William McChesney Martin) about the Federal Reserve’s role being to “take away the punch bowl before the party gets out of hand,” Summers suggested the Fed has shifted to a stance of “not doing anything until we see a bunch of drunk people staggering around.” This is because, he explained, monetary policy acts with a lag of 12 to 18 months, so the judgment that the Fed will withhold from rate action until substantial inflationary expectations have been proven is a significant risk.
6x?
Summers acknowledged that the size and impact of the 2008 stimulus passed to relieve effects of the Great Financial Crisis was too small–an assertion on which “everybody agrees,” he said, though they may debate whether that was due to political or economic factors. But, he said, he is “aware of no one who thinks it was too small by a factor of six,” which is what must be believed to accept that the size of the Biden Administration’s stimulus is appropriate.
Asked whether the Biden Administration had responded directly to the op-ed, Summers said diplomatically that he had read “very carefully and with great interest” a recent memo authored by economic advisers Jared Bernstein and Ernie Tedeschi rebutting concerns over post-covid inflation. According to Summers, the memo failed to address calculations about the (size of the) GDP (output) gap, failed to address concerns about rising prices from a variety of leading indicators, focused on labor market issues without addressing any suggestions in data that there might be emerging labor market shortages, and didn’t recognize the nature of the lags with respect to monetary policy.
“I guess I’d have to say that if that was the best case for being less concerned, I’m even more concerned about inflation after encountering it,” Summers said.
