Opinion | Larry Summers: what to do next on inflation


The debate over US monetary policy is at a new level. There is no longer any question that the Fed has allowed itself to fall behind the curve in the second half of 2021 and early 2022, calling its credibility into question. It is equally clear that, as its critics urge, the Fed has moved aggressively to contain inflation by raising rates and tightening quantitative easing. After these measures, along with the president’s release of the Strategic Petroleum Reserve and some luck, the Fed regained its credibility as a fighter against inflation.

Unfortunately, every major decline in inflation over the past 70 years has been associated with recession. It’s no wonder that many economists, including myself, expect a recession to begin in 2023. Historical experience as summarized in a proposal called the Sahm Rule shows that whenever US unemployment rises more than half a percent in a year, it will succeed. continues to rise by 2 percent. So, if a recession comes it is likely to raise unemployment to the 6 percent range.

What should the Fed do next? The choices from here are getting harder, not easier, as both the risk of a major recession and persistent inflation make policymaking more difficult. Chairman Jerome H. Powell was right in his December 14 press conference to emphasize that there is no basis for reliable economic forecasts.

Some of the most rigorous arguments are also the most stupid. Doves are wrong to argue that the Fed should clearly stop raising rates because inflation expectations are low. Hawks who suggest the Fed should continue to raise rates to far beyond past inflation are ignoring the fact that inflation is slowing — more likely than not if the economy faces a Wile E. Coyote moment in 2023, when demand slows.

Also Read :  Biden Claims US Economy ‘Strong,’ Draws Pushback

This can happen as small and medium-sized businesses hit a wall to refinance at high interest rates, as markets suddenly focus on what a recession can do to a company’s profits, as covid-era consumer savings fade, or as businesses hold on to their trade. workers realize they are no longer needed. Otherwise, oil prices may rise or political country risks may increase. In all these cases, policy makers will wish that monetary policy was less restrictive.

The Fed wants to balance the risk of stagflation caused by stable inflation expectations and the risk of a dangerous downturn. It is supported by the administration, which does an exemplary job of respecting the independence of the Fed. My instinct is that the Fed’s approach of stepping in as quickly as the situation becomes problematic is appropriate.

It is unlikely that we will have such a recession that we will drive inflation below the 2 percent target. Therefore, overshooting inflation is not the main risk, and the Fed is right to emphasize its goal of inflation going forward.

This judgment is supported by another theory. There has been a temporary fall in inflation caused by the slowdown in sectors such as used cars. As these constraints ease, and prices return to normal, there will be a pass deflationary impact that beats math. This should not be confused with a sustainable solution to the problem of inflation.

Also Read :  Dolce & Gabbana's Designs For 2022 Crystal Charity Ball Fashion Shows Served Up Food For Talk

Wage inflation is now at 5 percent or more, and labor markets remain very tight. Until wage inflation drops significantly or we get clear evidence of productivity growth, there is no basis for thinking that any low inflation rates seen will be sustained if monetary policy is eased.

Some suggest that the 2 percent inflation target is inappropriate in current circumstances, especially considering the cost of meeting it. Powell was right, in my opinion, to firmly reject this idea. I doubted at the time that setting inflation targets was a good idea, but now is not the time to change course. A change now to the 3 percent target, let alone more, would set the stage for a decade of rising rates. The 3 percent target will reach the standard, as the policy eases, and the economy slows down and the 3 percent appears.

Last year, the policy imperative was changing monetary policy which was behind the curve. Today, the lowest-hanging fruit of policy improvement lies in actions that can be taken by the entire government without the Fed. These include price cuts, measures to speed up the approval of energy projects promoted by Sen. Joe Manchin III (DW.Va.), measures to contain the cost of health and college education, and purchasing strategies aimed at less expensive shopping.

Monetary policy will have to respond whenever the economy slows down. There will be no room for big, over-the-board efforts. But now is the time to put in place carefully targeted measures to restore child tax credits, strengthen unemployment insurance and prepare to push federal spending toward savings and change cycles to times when overall demand is softer.

Also Read :  Opinion | Without day care and elder-care workers, the economy will founder

It is a tribute to the 2010 Dodd-Frank financial regulations that more monetary tightening has occurred with less market pressure. But the authorities must be aware of the lack of funds in many markets and the widening differences that have opened up in recent months between the valuation of the government market and the price at which many assets are carried on the private balance sheet. They also need to recognize the possibility that well-intentioned regulatory safeguards will interfere with liquidity in key markets.

The rest of the world will suffer greatly if the United States does not control inflation and prices eventually rise significantly above current levels, as happened in the early 1980s. The recent rise in prices and the dollar and the country’s exodus are creating major problems for many developing countries. The United States should lead the world’s efforts to solve the sovereign debt crisis quickly and increase the maximum level of loans from the International Monetary Fund and the World Bank.

Managing inflation and the risk of recession in a way that ensures a soft recession is impossible. But managing these risks with utmost care is critical as a foundation for long-term investment policies that will drive the inclusive prosperity that all Americans aspire to.


Leave a Reply

Your email address will not be published.