Fed still ‘much too optimistic’ on inflation

Ex-Treasury Secretary Larry Summers warned that the Federal Reserve’s forecasts on inflation have been “much too optimistic” so far — and warned that the US economy is teetering on the edge of a recession.

Summers, an early and frequent critic of the Fed’s response to surging inflation that reached fresh four-decade highs in May, also said he disagreed with current Treasury Secretary Janet Yellen’s recent claim that there was “nothing to suggest a recession is in the works.”

“When inflation is as high as it is right now and unemployment is as low as it is right now, it’s almost always been followed, within two years, by recession,” Summers said during an appearance on CNN.  

“I look as what’s happening in the stocks and bonds markets, I look at where consumer sentiment is, I think there’s certainly a risk of recession in the next year and I think given where we’ve gotten to, it’s more likely than not that we’ll have a recession within the next two years,” Summers added.

The dire warning followed a dismal May Consumer Price Index release that showed inflation jumped 8.6% — its fastest rate since December 1981. The numbers added to the challenge facing the Fed, which is attempting a high-wire effort to cool prices by hiking interest rates without tipping the economy into a recession.

Yellen, who recently admitted she was “wrong” about inflation’s path, said last week that economic growth would “absolutely” slow as the Fed imposed rate hikes but a recession was unlikely.

“I don’t think we’re (going to) have a recession. Consumer spending is very strong. Investment spending is solid,” Yellen told a New York Times Dealbook event.

Meanwhile, Summers told CNN that the decades-high inflation could rise even higher in the months ahead depending on the price of oil, which has surged since Russia launched its brutal invasion of Ukraine.

“There’s a risk that it will rise higher and I don’t think it’s likely to fall back very, very rapidly. I think the Fed’s forecasts have tended to be much too optimistic there and I hope they’ll recognize fully the gravity of the problem in their forecasts when they meet this week,” Summers said.

The Fed is expected to announce a rate hike of a half-percentage point at its meeting this week, with similar aggressive action expected in July and the months ahead if prices do not cool. The central bank’s previous half-percentage point hike in May was the sharpest increase of its kind since 2000.

Summers, who served as a top economic official during the Clinton and Obama administrations, added that there is “not a lot” that President Biden can do at this point to address gas prices that reached record highs over the weekend.

Summers said a “strategic” reduction in tariffs on China, as well as an overhaul of the corporate tax code and a reduction of prescription drug prices, could have a positive effect on inflation.

“We should focus on what’s important, not raising input prices for American producers so they’re less competitive, which is what much of those tariffs do,” Summers said.