Larry Summers warns the Fed risks 1970s-style crisis if it pauses inflation fight
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The U.S. economy faces an increased threat of a 1970s-style stagflation crisis if the Federal Reserve prematurely pauses its fight to crush stubbornly high inflation, former Treasury Secretary Larry Summers said on Friday.
The warning came in response to a controversial theory among some economists, including former International Monetary Fund chief Olivier Blanchard, that the inflation target should be raised to 3% from 2%.
"To suppose that some kind of relenting on an inflation target will be a salvation would be a costly error," Summers, a Harvard University professor who served in both the Clinton and Obama administrations, said during the World Economic Forum in Davos, Switzerland. "It would ultimately have adverse effects as it did in a spectacular way during the 1970s."
INFLATION EASES IN DECEMBER TO 6.5% BUT REMAINS STUBBORNLY HIGH
Lawrence Summers, president emeritus and professor at Harvard University, during a panel session on the closing day of the World Economic Forum (WEF) in Davos, Switzerland, on Friday, Jan. 20, 2023. (Photographer: Stefan Wermuth/Bloomberg via Getty Images / Getty Images)
Federal Reserve Chairman Jerome Powell has said repeatedly that the central bank remains committed to getting inflation under control and returning it to the 2% target, despite evidence that consumer prices are beginning to moderate.
The government reported earlier this month that inflation fell 0.1% over the course of December, the first monthly decline since 2020. On an annual basis, inflation rose 6.5%. While that remains about three times higher than the pre-pandemic average, it marked the sixth straight year-over-year slowdown, adding to growing signs that the worst inflation bout since the 1980s is fading in the face of higher interest rates.
The easing of prices has raised hopes among Wall Street investors that the Fed could pause its aggressive rate-hike campaign in order to assess the impact on the economy of tighter monetary policy.
Jerome Powell, chairman of the U.S. Federal Reserve, speaks during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington, D.C., U.S., on Wednesday, May 4, 2022. (Photographer: Al Drago/Bloomberg via Getty Images / Getty Images)
But Summers cautioned the central bank against taking what he warned could be pre-emptive action.
"It would be a grave error for central banks to revise their inflation target upwards at this point," Summers said. "Having failed to attain the 2% target and having re-emphasized repeatedly the commitment to 2%, to then abandon the target would do very substantial damage to credibility. If you can adjust once, you can adjust again."
Fed's Brainard expects interest rates to remain high despite recent inflation decline
He added: "The counter-factual is not, 'Can we have more inflation and no recession?' It is, ‘If we fail to deal with inflation, we are likely to have a more severe recession at some point.’"
The Fed raised its benchmark interest rate to a range of 4.25% to 4.5% last year in the most aggressive tightening campaign since the 1980s. At their last meeting in December, officials slowed the pace of rate hikes to a 50-basis-point increase, following four straight 75-basis-point hikes.
U.S. Federal Reserve Chair Jerome Powell attends a press conference in Washington, D.C., the United States, on Nov. 2, 2022. ((Photo by Liu Jie/Xinhua via Getty Images) / Getty Images)
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The central bank typically moves the benchmark interest rate in 25-basis-point intervals.
The policy-setting Federal Open Market Committee next meets from Jan. 31 to Feb. 1; markets widely expect policymakers to downshift further and approve a quarter-point hike, according to CME Group data.