Larry Summers warns that the Fed is too optimistic and faces risks of high inflation, low growth, or both.

Larry Summers warns that the Fed is too optimistic and faces risks of high inflation, low growth, or both.

Summers Warns of Possible Stagflationary Dynamic as Fed Display Optimism

Renowned economist Lawrence Summers has cautioned against the Federal Reserve’s optimism, stating that there is a significant likelihood of higher inflation and weak growth. In an interview on Bloomberg Television’s Wall Street Week, Summers expressed concerns about the Fed’s projections, suggesting that a stagflationary scenario could materialize.

The Federal Reserve had recently increased its forecasts for economic growth in the coming years while reducing its estimate for core inflation. However, Summers believes that there is a possibility of the Fed getting surprised by higher inflation or weaker growth, or even both. He further commended Fed Chair Jerome Powell for abandoning forward guidance and being open to flexible responses based on evolving data and the outlook.

Summers acknowledged that while the Fed may need to move rates upwards more than they are currently projecting, the risks are two-sided. His concerns align with the growing sentiment among analysts who had previously predicted a US recession but have now postponed or abandoned those predictions due to decelerating price and wage gains, as well as resilient economic growth.

The former Treasury chief highlighted several risks that the economy currently faces, including the strike by the United Auto Workers union against carmakers, a fiscal deficit approaching 8% of GDP after adjusting for student-loan accounting, rising health insurance costs, signs of slower consumer spending since Labor Day, and the potential increase in borrowing costs as corporate loans and bonds roll over.

Summers emphasized the significance of labor power in understanding the changes in the economy over the past few decades. He referred to President Ronald Reagan firing air-traffic controllers during their 1981 strike for higher wages as a turning point in the engagement between workers and employers. With recent high-profile labor conflicts and the potential for significant wage increases, Summers suggested that organized labor’s push for compensation gains could yield substantial changes in the economy and may complicate inflation issues.

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While Summers did not outright predict the outcome, he urged caution and vigilance regarding the long-term impacts of these union developments on the economy. The labor push may introduce wage pressures that could complicate inflation dynamics.

Summers concluded by stating that it is wise for the Fed to under-forecast and over-perform, considering the current optimism prevailing among analysts and policymakers. As the economy navigates these potential challenges, maintaining a prudent and flexible approach will be crucial for the Federal Reserve.