Summers warns of ‘economic distress’ as Fed’s Powell remains hopeful

Summers warns of 'economic distress' as Fed's Powell remains hopeful

“Unless we have a very surprising and positive set of developments,” Summers told POLITICO: “We are not likely to see the inflation rate come down all the way [the Fed’s] target without some level of significant economic distress.” Summers, who was also a senior adviser in the Obama White House, has derided the Fed’s previous forecasts as “delusional.”

The result has far-reaching implications for the country, including for countless American families who have benefited from an extraordinarily strong labor market but have also faced historic price increases that have consumed increases salaries and family budgets. It also presents a huge challenge to Joe Biden’s presidency, as a miscalculation by the Fed could lead to a tanking economy, persistently high inflation, or worse, both.

Although the Fed in June saw the unemployment rate reaching 4.1 percent by the end of 2024, some economists say it may need to rise to nearly 6 percent, and stay there for a while. to reduce inflation, an increase that would certainly coincide with a recession.

Diane Swonk, chief economist at KPMG, said it’s no longer a question of whether the Fed can avoid a recession, but whether it will accept a mild cut that slowly reduces inflation or a bigger one that does the job quickly.

“The Fed’s optimal scenario is that we arrive with only a modest increase in unemployment,” Swonk said. “I think within the Fed, there’s some recognition that maybe it should be more than that.”

The Labor Department reported Friday that employers added 528,000 jobs in July, well above economists’ forecasts. The unemployment rate fell to 3.5%.

Even so, broader economic activity has clearly slowed. The government said last week that gross domestic product fell in the second quarter, after a decline in the first three months of the year, raising concerns about an impending recession.

Meanwhile, Powell is under pressure from some left-wing economists and politicians, such as Sen. Elizabeth Warren (D-Mass.), who argue that the Fed’s campaign to raise interest rates will do little to quell inflation, which is largely driven by supply shocks such as the war in Ukraine and the blockades Covid in China. In a Wall Street Journal op-ed last week, Warren also blasted Summers as a “cheerleader” for higher rates and “someone who has never worried about where his next paycheck is coming from.”

Other skeptics say the Biden administration and Congress need to do more to help the Fed control prices and avoid derailing the economy.

“A recession will not help us deal with inflation; a recession will only hurt working families,” the senator said. Sherrod Brown (D-Ohio), chairman of the Senate Banking Committee. “We need to lower prices for workers and families, and tackle inflation at its source, this means fighting rising and consolidating business prices, expanding our housing supply and investing in our supply chains”.

Senator Sherrod Brown speaks at United Performance Metals in Hamilton, Ohio on May 6, 2022. | Andrew Harnik/AP Photo

Democrats are poised to advance the legislation, negotiated by the Senate majority leader, soon Chuck Schumer and Sen. Joe Manchin ( DW.Va. ), which they say would help ease price pressures by reducing federal budget deficits, although some forecasters estimate the effect on inflation would be small and not materialize immediately.

Powell says the Fed doesn’t have the luxury of ignoring supply constraints and waiting for inflation to come down on its own. And he stressed that policymakers won’t be opposed to slower growth or a softening labor market as they continue to raise rates.

“These are things that we expect, and we think are probably necessary … to be able to get inflation back on track to 2 percent and eventually get there,” he told a news conference last month.

How much pain will it take?

Summers compared the process to an addict going through detox — it will involve some withdrawal symptoms. For now, the Fed still expects these symptoms to be mild, although Powell acknowledges that the path to avoiding recession has narrowed.

In June, Fed officials projected that inflation would fall from an estimated 5.2 percent at the end of this year to just above its 2 percent target by the end of 2024. At the same time, they expected the unemployment rate to rise by only half a percentage point. point, to 4.1 percent, from 3.6 percent in June.

Some of their optimism reflects officials’ view that a decline in job openings could take some heat out of the labor market and help ease price pressures without raising unemployment much.

As the economy slows down, employers tend to pull back from hiring and start laying off people. But with so many vacancies relative to the supply of available workers, Fed officials hope that a decline in job openings won’t necessarily correspond to such a large increase in the unemployment rate this time around.

Larry Summers speaks at FOX Studios.

Former Treasury Secretary Larry Summers visits the FOX Business Network at FOX Studios on January 30, 2015 in New York City. | Rob Kim/Getty Images

Not everyone is convinced.

In a newspaper last month, former International Monetary Fund chief economist Olivier Blanchard, Harvard research fellow Alex Domash and Summers said the Fed’s hope “flies against the theoretical and empirical evidence.” Looking back at labor market data since the 1950s, there has never been an example in which the vacancy rate fell substantially without a significant increase in unemployment, they wrote.

“The fight against inflation will require a decrease in vacancies and an increase in unemployment,” they wrote. “There is no magic tool.”

They also argued that the so-called natural rate of unemployment, the rate at which economists believe unemployment begins to fuel higher inflation, is much higher than before the pandemic. That means the labor market is even tighter than many assume, and the unemployment rate will have to rise much more than the Fed expects to reduce inflation, they wrote.

Fed economist Andrew Figura and Governor Chris Waller rejected in a blog post Friday, saying a soft landing is still possible. They acknowledged that “it would be unprecedented for vacancies to decline to a large extent without the economy falling into recession,” but said this is an unprecedented situation.

The problem is that the Fed doesn’t have precise tools to target a particular vacancy rate or unemployment rate to slow the economy just enough to reduce inflation. And he doesn’t have a “recess” button that he could press even if he wanted to.

That raises the risks that the central bank will raise rates too high, triggering a painful contraction and potentially pushing inflation too low, said economist Wendy Edelberg, director of the Hamilton Project at the Brookings Institution.

The biggest concern, he added, is that the economy will slow and inflation will remain high. This could happen if inflation expectations start to rise or if supply shocks continue to hit the economy.

A recession may still not be necessary if supply constraints begin to ease, said Claudia Sahm, a former Fed economist. “If we don’t solve the supply problems, we have to see consumers slow their spending,” he said. “Growth must be slowed down, business investment is slowed down. Things just need to heat up a little.”

But ultimately what the Fed wants to see is inflation coming down, and it’s up to Powell and his colleagues to decide how quickly they want that to happen.

“If they want 2 percent and they want it now, they can get it,” he said. “But to achieve that, we would need a recession.”



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About the Author: Chaz Cutler

My name is Chasity. I love to follow the stock market and financial news!