Home News US Economy

Summers warns of 1970s crisis if central banks relent on rates

Bloomberg1/20/2023 08:58 PM GMT+08  • 3 min read
Summers warns of 1970s crisis if central banks relent on rates
Photo: Bloomberg
Font Resizer
Share to WhatsappShare to FacebookShare to LinkedInMore Share
Scroll to top
Follow us on Facebook and join our Telegram channel for the latest updates.

Going soft on inflation will plunge economies back into the recessionary depths of the 1970s and have “adverse effect on working people everywhere,” former US Treasury Secretary Larry Summers warned.

The remark is a response to suggestions from economists including Olivier Blanchard, a former International Monetary Fund chief economist, who have suggested lifting inflation targets from 2% to 3% to avoid recessions.

“To suppose that some kind of relenting on an inflation target will be a salvation would be a costly error, it would ultimately have adverse effect as it did in a spectacular way during the 1970s,” Summers, a professor of economics at Harvard and a Bloomberg TV contributor, told a panel at the World Economic Forum’s annual meeting in Davos, Switzerland.

Federal Reserve Chair Jerome Powell has repeatedly made clear that the US central bank has no plans to change its 2% inflation target.

Inflation peaked in double digits across much of the industrialized world but is expected to drop rapidly this year on the back of falling energy and commodity prices. However, core inflation will remain elevated as wage behavior and companies’ price setting has fundamentally changed, Swiss National Bank Chairman Thomas Jordan said on the same panel.

“It will be much more difficult to bring inflation from 4% to 2%,” he said. “We will see if that comes with a recession or not. Firms do not hesitate any more to increase their prices. That is different from two or three years ago and is a signal that it is not that easy to bring inflation back to 2%.”

See also: As Fed nears the rate peak, be careful what you wish for

“We also see a change in the behaviour regarding wages. If you look at wage formation, this is very backward looking. Basically we take inflation from last year and we use this to set future salaries – the kind of fairness argument. Once inflation is high, the pressure from wages is here.”

Summers warned: “It would be a grave error for central banks to revise their inflation target upwards at this point. 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.”

“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.’”

See also: Differing Powell and Yellen messages were a lot for the stock market to digest

Central bank chiefs on the panel all agreed that tighter monetary was still needed to bear down on inflation, which still close to 10% in the US, the Eurozone and the UK.

Summers also criticized central bankers’ operation of quantitative easing during the pandemic, which he said has added to the burden on taxpayers. Under QE, central banks were effectively swapping long-dated debt for very short-dated debt just as “every corporate treasurer in the world was terming out its debt” to take advantage of low interest rates.

The Fed is now carrying a mark-to-market loss on its balance sheet of around $800 billion, he said.

“In retrospect, I think that was highly problematic,” Summers said. “We need in addition to thinking about the stimulative aspects of QE to focus on the balance sheet debt maturity aspects of QE.”

Loading next article...
The Edge Singapore
Download The Edge Singapore App
Google playApple store play
Keep updated
Follow our social media
Subscribe to The Edge Singapore
Get credible investing ideas from our in-depth stock analysis, interviews with key executives, corporate movements coverage and their impact on the market.
© 2022 The Edge Publishing Pte Ltd. All rights reserved.