Former Treasury Secretary Larry Summers worries that investors and economists are becoming too optimistic after inflation cooled to 6.5% in December.
“One must be careful of a false dawn. If you think about it, the good news is that inflation is running in the 6th year, and this is still very high compared to the standards of two or three years ago,” he said. Bloomberg on Friday, adding his forecast is still that “a recession this year is more likely than not.”
Since March, Federal Reserve officials have raised interest rates seven times in hopes of reducing inflation without triggering a recession, and all the while, economists and Wall Street analysts have debated whether they will succeed. Summers has met at the bear camp many times. In October, he told the Financial Times that would take a “recession” and “unemployment into the 6% range” to ensure US inflation truly disappears.
But economists admitted on Friday that the latest inflation report was “good news” – and it came despite the unemployment rate being just 3.5% in December. He said this is evidence that wages are not rising too much, which means the Fed may need to change tack.
“Certainly, looking at some of these trends, one has to think that the Fed’s work is much, much closer to being done,” he said. “And I think the chances are more optimistic [for the economy]while it’s still not my bet, it seems more believable now than it was a few months ago.
But despite admitting that the new inflation data was “good news,” Summers insisted that the Fed should continue to raise interest rates in February because wage pressures have not yet resolved. Real average hourly earnings, which take into account inflation, rose 0.4% last month, up slightly from November’s 0.3% rise and October’s 0.1% decline.
“I think the most important thing is that the job of containing inflation is done and maintaining credibility,” he said of the Fed. “So I think it’s a little premature to think about taking a break, but we’re getting closer to that day.”
In a September interview with fortune‘s Shawn Tully, Summers explained that the Fed’s interest rate hikes are like antibiotics for the economy—and if we don’t take the medicine for long enough, inflation could become a long-term problem.
“A lot of us have learned about it [when] The doctor prescribes antibiotics and you stop taking the course when you feel better than if the prescribed course is over, your condition will recur,” he said. “And it will probably be more difficult to eliminate the next time because the bacteria have become more resistant.”
On Friday, Summers pointed to the Employment Cost Index (ECI) – which measures the average cost per hour of work in the US and is set to come out January 31 – as a true test for the Fed and the economy. He called the index the “gold standard measure of labor costs and wage pressures.”
The economist has said for months that central bank officials must slow the labor market and contain wage increases to control inflation, even telling reporters in June that it might take “five years of unemployment above 5%,” according to Bloomberg. And he believes the ECI will be the perfect test of whether interest rate hikes have begun to do the job.
But other Wall Street leaders, including JP Morgan Asset Management global strategist David Kelly, believe the Fed is doing enough to stop inflation. Kelly said there that the central bank will likely raise interest rates by another 75 basis points between now and May, but he hopes it will not.
“I think we have to stop,” he said Bloomberg. “This is a war that has been won, and there is a danger that the economy will go into recession. I think they are making the fiscal problem worse, so I want it to end.
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