Larry Summers: The Fed Must Do Much More to Fight Inflation

During the 1960s and 1970s it took a dozen years for a toxic cocktail of excessive fiscal stimulus, misguided monetary policy focused on symptoms rather than causes, and bad luck on the supply side to generate stagflation—a combination of high inflation and a stagnant economy. Public trust in the government was eroded, political dysfunction led to stagflation that weakened public confidence and ultimately brought down both Jimmy Carter and Gerald Ford.

The pace of history has increased over the years and policy mistakes like the 1960s and 1970s, along with poor luck, have brought America to the brink stagflation. The income support payments made to businesses and households in 2021 were far more than any estimation of the income loss due to COVID-19. Akin to the 1970s, Federal Reserve stated that inflation was temporary. It could be isolated to some sectors and not all. However, labor shortages were unprecedentedly severe. The Ukraine crisis now has huge implications for food and energy prices. Inflation is expected to continue rising for at least two more months, as the effects of commodity price increases are felt throughout the system. Then it may recede but not in all likelihood anywhere near the Fed’s 2 percent target.

It is no surprise that Americans believe the country is in the wrong direction when inflation is at 7 percent.

As with any other time since Reagan’s disinflation, small businesses are much more likely to point out inflation as the main worry. As consumers experience the greatest decline in their purchasing power in years, the Dollar Store is now the #1.25 Store.

There aren’t easy or painless methods to ensure that the economy has a smooth landing. Even before the recent oil and food price booms, it was impossible to believe that there would be no inflation. The strategy of hope isn’t working. Although there may be areas in which increased antitrust enforcement is necessary, making corporate greed the cause of inflation seems absurd to almost all economists. If there is a single clear lesson from the 1970s it is that Richard Nixon’s price controls were a disaster that actually exacerbated the build up in inflation by reducing the pressure for needed monetary restriction.

The urgent prerequisite for success in achieving a soft landing is a clear recognition by both the Administration and the Fed that the economy’s current level of demand is unsustainable and has been for some time. Now is not the time to indulge in sugary highs, but to eat well. As long as we continue to allow excesses in the financial market and real economy, the harder it will become for us to adjust.

I welcome the Fed’s moves to phase out quantitative easing and raise interest rates. However, they’re not enough. With hundreds of economists and employers reporting increased costs, the Fed is unable to explain why it was able to underestimate 2021 inflation by an average of 3. Without this explanation, it’s difficult to feel confident in their ability to control things.

The Fed has not indicated an intent to change the operational framework that led us to this point. It continued to exclude monetary tightening from the moment it became clear that the economy is overheating. The President‘s new nominees to the Board while clear on their commitment to disinflation have yet to make clear their recognition that inflation has its roots in an overheated economy.

With respect to inflation, the Fed is the main actor. Biden Administration policies are also important. Unfortunately, the Administration tends to emphasize ideas that have merits but which will have little effect on inflation for many years. For example, it may initiate antitrust actions within a handful of industries or build new infrastructure. It also promotes ideas that are anti-inflationary, such as Buy America policies which require suppliers to shift from low cost to high cost. As another example, if the Keystone pipeline had not been rejected it’s probable that it would be providing more oil to America than we are losing from the Russian embargo.

Focusing on cost savings for consumers would be a more positive agenda. Let market forces operate. Retiring Justice Stephen Breyer’s major contribution to American policy was his work with Senator Kennedy to deregulate airlines. The Jones Act is obsolete and should be repealed to reduce shipping costs. In a moment when housing costs have risen, why not reduce shipping costs by repealing the Jones Act? To put it another way, tariff cuts directly reduce the prices of consumers as well as make exporters more competitive through lower input costs.

Some policy issues are impossible to resolve. These problems are difficult to fix because we lack the necessary knowledge and tools. But inflation. We all know how to lower it. It is clear that price restoration will take longer and be more difficult if we don’t act quickly. It’s time to act.

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