Lawrence H. Summers, Former U.S. Treasury Secretary (1999-2001); Charles W. Eliot University Professor and President Emeritus, Harvard University(joining remotely)
In conversation with: Alan Murray, FORTUNE 


CEO Initiative 2022 - Inflation Risks For America And The Global Economy

Conferences

Lawrence H. Summers, Former U.S. Treasury Secretary (1999-2001) President Emeritus, Harvard University
Alan Murray, FORTUNE 


Inflation Risks For America And The Global Economy


CEO Initiative 2022 - Inflation Risks For America And The Global Economy


So last year when economic officials and pundits and some of the administration officials seemed to overuse this word transitory. Our next guest was the person who really sounded the alarm about the risk of runaway inflation. And of course he was right when joe Manchin worried that the inflation reduction act would contribute more to inflation, uh, this guest talked to joe Manchin and basically convinced him it wouldn't, I think he was right about that as well. Larry Summers has been very clear and and almost alone in some cases in arguing that there is a difference between the inflationary effects of government spending that just feeds consumption and government spending that, uh, that can stimulate investment, like climb the climate provisions of the inflation reduction, childcare, uh, things like that. He's probably the one economic policy commentator who has has gotten it right for the last few years, which is why we've invited him here today to speak with all of you couldn't be here in person. So we're gonna bring him in virtually to have that conversation. Thanks Larry. I know you're there somewhere great. How are you Very well and it is good to be good to good to be with you, my friend. Even better to be here in person. We're with the warm weather. So we're sorry. We do. We we don't have you here, but thanks for taking the time. Professor has obligations to his uh classes that even exceed his obligations to his friends for 40 years like you. Well, well, thank you. Well, we'll we'll take this deal and thanks for thanks for being with us. Look, my big question for you. Larry is, is, I mean, we saw the Fed yesterday move another 75 basis points. We have brian Moynihan on the stage last night saying when he looks at the data, he doesn't see any slowdown. And so so my big question for you is, What is it gonna take, how much to interest rates have to move? How much economic pain are we going to have to suffer in order to get inflation back down to 2%. Um, I alan agree with my friend brian that the economy is running fairly strong right now and stronger than I probably would have expected. I was struck by the number that came out on monday that the number of vacancies in the economy had popped back up suggesting that we were moving back to a labor short economy. There's nothing that I've ever seen in economic experience that suggests that inflation comes way down and we've now got inflation at seven. So it has to come pretty far down without there being some meaningful amount of restrictive policy. And then that restrictive policy also restricts growth and employment, uh, in the economy. So I yanked after a long period when the Fed was really not in the right place at all and almost had its head in the sand. Um, believing in a transitory theory. Chairman Powell's navigating it into the direction into the right broad area. The markets now expecting that the federal funds rate just got increased core will get up somewhere in the 5, 10, 5 and a quarter range by next april my guess would be that the inflation pressures are still going to be a little greater than people supposed from the labor shortage. And so my guess would be that interest rates will end up that funds rates will end up above that. I would not be amazed if they got to sex, but that's certainly not what I would be uh predicting. I think it's very hard to know what's going to happen to inflation and unemployment. Um my instinct is that in some ways it's easier to forecast the two of them together than to forecast one of them alone. If we are actually on a path that brings inflation back close to the 2% target, I think we're likely to have seen a meaningful increase in unemployment. Um But whether we will actually push the process as hard in terms of disinflation, I'm less certain. Yeah, norman Powell certainly been very, very clear about his intent, but he hasn't really been clear about his intent at the same time, that he's been recognizing the price of his intent In terms of higher unemployment. It's a little bit like if I said I was going to buy an apartment in New York, you'd believe me. But if I said I was only gonna pay $500,000 for it, then you'd wonder whether I was really going to uh do it. That's a bit how I feel about the Fed's forecasts that unemployment will never go above 4.5% and and you know we've we've uh you and I at least are old enough to have seen this movie before, are we better off as an economy to uh to take the hit now or uh to spread it out over time? You know if you don't if if it's a mild recession and it doesn't get the uh get inflation down as much as he needs uh needs to be. Can can you do that slowly over time rather than in a in a big hit all at once. There's lots of metaphors, you can have a you can have a battle of metaphors talking about pulling band AIDS off and stuff like that. But I think the more serious way to think about it is that I think the best point that the people who are far more dovish than I like Paul Krugman um make is that unlike in the 1970s we have not yet seen a big increase in five or 10 year inflation expectations. So right now there's still a sense that we're in the range of price stability and that this has some temporary element in it and that puts a lot of wind at the back of anybody trying to reduce inflation. But if we let this continue for too long, we will lose that advantage. And that's why I think it is likely that the total cost of containing the inflation will be lower if we act more rapidly rather than if we act less rapidly. And I think it's important to remember that core inflation right now, you know, on the last figure was seven to the nearest round number and that was more than the month, was more than a quarter and a quarter was more than a half, a year and a half year was more than the year. So it certainly wasn't coming down fast and after yesterday we've got interest rates at four. So it's not like we're stepping on the brake with unprecedented force or anything like that, or anywhere close to stepping on the brake with unprecedented uh force. So for now, I think the the risk of doing too little is greater than the risk of doing too late. And I think one other point out, and maybe you'll disagree with me on this because you've been covering this stuff for 4.5 decades. Um I can think of a variety of moments when in retrospect the Federal Reserve or some other Central bank should have raised rates more and been more disciplined about inflation. Everybody worries that the Fed is going to move to move too quickly that they're going to forget the lags and then we're going to get an economic downturn and it's certainly something that has to be balanced. But I'm not aware of a historical moment when that ever happens. And in general, I think it's better to worry about negative scenarios that have occurred before than negative scenarios that have not occurred before. That doesn't mean there isn't a risk and that doesn't mean that the Fed doesn't have to strike a balance. But to put the point another way, is anyone really thinking that we're gonna have such a bad recession That it's gonna push inflation below the 2% target? And if we're are serious about the 2% target, then why would we think that policy had been to contractionary if inflation is not falling below the 2% target? Now there's a set of arguments, I I understand them. I think i it wouldn't be my arguments that we should not have a 2% target, we should have a higher target for inflation, But gosh, when you've made it made the kind of mistakes the Federal Reserve has made over the last year and a half of not taking inflation seriously and pounded away your commitment to a target. This doesn't seem like the moment to abandon that target. There is a line of thinking and you've already alluded to it, a line of thinking that because expectations are not dug in the way they were when paul Volcker uh took over the Federal Reserve, that it's gonna be easier to deal with, for instance, one of the things, some people, I think with some economists at Goldman Sachs who argued we don't actually have to raise the unemployment rate to combat inflation. We just have to bring down the unfilled jobs rate, eliminate some of that competition. Uh for jobs is it possible we can get out of this with uh with less pain than you seem to be suggesting. Here's a here's a piece of advice for all your viewers. Any any economist who says that something is impossible where they're sure that something will not happen is an economist whose opinions you should dismiss. So I answer all questions of the form. Is it possible by saying yes If you ask me. Um however uh is it likely. Um and you make that comparison with volker? I would make two points. The first is that Volcker's disinflation pushed the unemployment rate to 10.8% and nobody not the fiercest talk anywhere on the planet thinks we should elevate unemployment Halfway to 10.8% from where we are. Now. The second is this seductive idea and I think it is seductive that we can just get rid of the vacancies and not have any increase in our employment. Here's the fact right now the excess of vacancies over their normal level is about twice as large as it normally is in periods of strong economic performance. So the number of vacancies we might have to eliminate is kind of two x. There have been nine previous instances since World War Two when vacancies came down significantly. In every one of them unemployment went up substantially. So maybe it will turn out that this one is different. And you can argue that their special features of the post covid economy, you can argue that precisely because vacancies are so high this time is different. But in general if you have to bet with nine previous experiences or bet with no previous experiences and optimism, I think the better bet is with nine previous uh experience experiences. But again, anything is possible, frankly. The argument you're making looked better to a lot of people including me four days, five days ago before they got the most recent vacancies data because there had been a big decline in vacancies last month without any increase in unemployment. But now a quarter or a third of that of that decline got revised away and about half of that decline got reversed. And so you're seeing it, you're seeing it much less right now. But look, you don't leave a lot of room for argument. Larry anything is possible. You don't leave a lot of room for argument. I I'm gonna have a lot to a lot to talk to you about. But I also want if anyone in the in the group here has has a question just stick your hand up and we'll get a microphone to you. Uh Look you were according to the reports I read in large part responsible for convincing joe Manchin who's gonna be with us in just a few minutes, convincing joe Manchin to switch his position on the poorly named inflation reduction Act uh to uh to support it rather than oppose it. Um Can you share? And it's a really important argument I think for people thinking about the effects of of government spending, Can you share the argument you made? I don't know. I don't get into my private political conversations and I never take credit or blame for the political decisions than anyone. I've given advice to. Those are their decisions. What I will do, Alan is say what I thought about the inflation reduction act. In contrast to what happened before. There were three differences between the inflation reduction Act And the rescue act that took place at the beginning of 2021. 1st, the inflation reduction act was $600 billion 10 years, whereas the rescue act was plus the earlier stimulus was $2.8 trillion dollars over one year. So there was a total difference in scale. Second, the reduction Act was paid for fully by tax increases and other revenue increasing, so there was net no net change in the demand balance. And third, substantial parts of the reduction act were measures that would increase the economy's supply potential over over time, not simply pump up the level of demand. So factor of 10 difference in scale paid for versus not paid for expanded uh increased capacity versus just increased consumption spending? Those were the reasons why? I thought they were very different. It's that third, it's an inflationary impact. Yeah, it's that third one that's kind of unique. And you laid this out before this administration even came in that if you're investing, if its investment in uh the energy transformation or maybe also in something like child care or training, that has a fundamentally different effect on inflation. Do you feel like you've made progress with that argument? Making some progress? Look, it's it's the same basic logic for the government as it is if you're advising your kids, if your kids want to borrow money to go to go educate themselves or they want to buy borrow money to buy the house of their dreams they're gonna live in for 30 years. That's probably a very reasonable idea, particularly if interest rates are low and they're locking in a low rate if your kids want to borrow because they didn't earn as much money as they have liked to and they still want to eat out a lot and take a lot of vacations. That's probably much less sound borrowing. And some parallel principle applies with respect to uh the government. Yes. And I think I think that is becoming better understood. Um So, so uh Larry this, I know you are still in close contact with people in this administration, the administration is from time to time, uh, blamed inflation on corporate concentration or corporate profiteering. What do you think of those two arguments? I don't think that those are the administration's soundest economic pronouncements. Um, look, I think there are a number of areas where we should have stronger antitrust enforcement, but I don't think inflation has anything much to do with uh, gouging or monopoly power. And I think some of the doctrines that have been put forth by the so called neo Grand icings, um, are really very radical and very unfortunate and are the wrong places to go. Look, I think there are issues that democrats are right to have with business. Uh, there's some stuff with corporate tax shelters that have carried interest tax break, a variety of things that I think are kind of outrageous, but I think some of the regulatory kinds of agendas that treat profit as a bad thing, treat uh, business as a money pot, uh, failed partner. I don't think that's the right approach uh, for people to take in terms of uh, getting things, getting things done. I like approaches based wherever possible on partnership much better. And I think there's some real potential in uh, the green area in particular to do that. I think the chips act is gonna be a very important test of how well as a society we can do in having government business partnerships on some really important issues. I'm glad you raised the chips act because the last time you were on a Fortune stage conference stage Was in in the fall of 2018 in Toronto at the Fortune Global Forum. And I remember how you ended that conversation, you you said the most, the most consequential uh, thing to watch for economics and the world over the coming decade was the relationship between the us and Japan. Uh, that was five years ago. I'm sorry. I misspoke china china. Yeah, yeah, I misspoke apologies. I'm still waking up U. S. And china. It was china. My my totally misspoke uh, five years have passed. What and a lot has happened in the US china relationship over those five years. Uh, what do you see now, by the way, I think you're going to make a habit of remembering what I say at fortune. Oh yeah, throwing it back in my face five years later. I mean you get a lot more fortunate. Uh, But in this case, um, I'm Glad I said that because I think it was right. I would say relative to what I would have expected, then we're in about the 15th or 10th or 15th%ile of outcomes. I think on the, on the bad side, because I would say the relationship has massively deteriorated on both sides. I think primary responsibility for that uh, rests with uh, xi Jinping and a variety of excessively assertive, aggressive nationalist discriminatory totalitarian policies that china has followed. But I don't think the United States has yet in place a sound strategy beyond pointing up its legitimate indignation but warranted indignation does not constitute a strategy. And I am very concerned that the situation has more and more overtones of Britain and Germany As one moves from 1910, towards uh 1914. Some of it is uh, geopolitical and the difficulty in maintaining the peace through ambiguity approach that has been that has been successful in Taiwan for 50 years. Some of it has to do with the question of rules governing trade. The most undercovered story of the last three months and maybe of the last three years has been the extent to which the american uh government launched a kind of economic warfare on china with the semiconductor uh, restrictions that were announced several weeks ago. Now, I don't have access to the classified information that would permit me to judge whether those steps were uh, necessary uh or not. But I do think they're framing um, was very much one in terms of a kind of economic warfare and holding the china down rather than limiting access just to key military technology. And I think that has to strengthen the hawks uh, in china. And so I hope when President biden and Premier G meet in bali, it can be a basis for not getting this to affection, God knows, not getting this to partnership. Uh, God knows, but of stabilizing it because I think we are, we in china are like two guys each of whom holding or in a lifeboat, a small lifeboat in a turbulent sea, a long way from shore. We depend on each other. Um, even however we may feel about each other. There's no alternative to finding a way of functioning together. Uh, Larry, on that encouraging note. I will let you get back to your teaching, but, but thanks for taking some time to speak with this group. But we really thank you. Thank you for having me. Thank you for having me.