Former Treasury Secretary Larry Summers was right to believe that inflation would be lasting longer than Federal Reserve and White House officials believed at the beginning of the year.
Summers says that the Fed, which is likely to forecast multiple interest rate hikes next year, will have a hard time putting the inflation genie back into the bottle without a recession.
In a webinar held by the American Council for Capital Formation he likened monetary policy to trying to adjust the water temperature of a shower in an old hotel due to the lag in how the economy responds. He said that the Fed has caused a number of recessions when it reacts to inflation.
There have been moments when the Fed acted mildly and preemptively, 1995 for example, to create a pause that refreshes with respect to expansion, but that was when it was activating with a doctrine of looking ahead, not the current doctrine of no action until inflation is absolutely established. He said that the difficulty of engineering a soft landing in which inflation comes down but we don't see a real problem is very challenging.
Summers warns of a spontaneous deflating of financial assets, ticking off cryptocurrencies, meme stocks, technology stocks, and SPACs. Super excited retail is usually a sign of trouble coming, he said.
The Nasdaq Composite COMP has fallen 5% from its record high.
Summers said he was glad to see that Fed Chair Jerome Powell and Treasury Secretary Janet Yellen are retiring the word transitory from their vocabulary. He said the Fed should immediately stop purchasing mortgage-backed bonds and phase out government bond purchases by the end of the first quarter, which will allow for multiple rate hikes.
The idea of gradual increases of rates will be sufficient to contain inflation, according to Summers, given what is happening in the labor market.
Summers said he was against the size of the $1.9 trillion stimulus plan signed into law by President Joe Biden. He predicted a GDP gap of about 3%, but the stimulus provided aid equivalent to 14% of GDP. Labor income was running about $25 billion a month lower than the trend, which is why $200 billion a month of aid was provided.
Summers said that the significance of the omicron variant is that it is a much more dramatic mutation than what was previously seen, which implies that another major mutation could also come. He said it is possible that the coronavirus situation is in the fifth inning rather than the seventh because of the baseball analogy.