Fmr. Treasury Sec. Lawrence Summers: Is a Recession Coming?

CHRISTIANE AMANPOUR: Now, the public health battle against Omicron is growing up — is coming up against the economic cost. Like in many countries, inflation in the United States is gathering steam and hitting people hard with rising food and housing and gas prices. Walter Isaacson has been speaking to Former Treasury Secretary Larry Summers about how to write this ship.

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WALTER ISAACSON: Thank you, Christiane. And Professor Larry Summers, welcome to the show.

LAWRENCE SUMMERS, FORMER U.S. TREASURER SECRETARY: Good to be with you, Walter.

ISAACSON: So, you’ve been warning for a really long time that we’re going to get hit by inflation. And the fed kind of ignored you until this week when it decided it’s going to raise interest rates, maybe three times next year. Quit buying bonds. Is this too little, too late that they’re doing?

SUMMERS: It’s probably the beginning of a process, Walter. If you look at it, real interest rates are now 2 percentage points lower than they were at the beginning of the year, even as unemployment is falling fast and inflation has risen rapidly, and they’re talking about an increase of three quarters of a percentage point in rates next year. I think they’re going to have, over time, have to do considerably more, and it’s a very delicate process once you have excessive inflation. The historical experience has been that it’s pretty difficult to contain inflation while at the same time engineering a soft landing for the economy. So, because things have reached this point, they’ve got a very difficult challenge ahead of them. Not made any easier by the fairly significant degree of fraught that we’re seeing in financial markets.

ISAACSON: So, tell me. What are the underlying causes right now of the inflation?

SUMMERS: There’s one overwhelming cause. And that is that we took an economy that had a shortfall of demand of perhaps 2 percent 30ror 3 percent of GDP in 2021, and we put 10 percent to 15 percent of GDP worth of demand into it. And so, the consequence was high demand, limited supply pushing the level of prices up and causing inflation.

ISAACSON: You’re talking about the federal spending?

SUMMERS: I’m talking about the federal spending along with the $2.8 trillion that Congress appropriated, largely in the form of transfer payments of various kinds to non-poor households and to state and local governments.

ISAACSON: So, was that a mistake?

SUMMERS: The size of it was a big mistake, yes. As I warned at the time, we spent a huge amount of money just as households were unprecedentedly flush because of all the savings they had generated involuntarily because you couldn’t take a vacation or go to a restaurant during 2020. On top of that, you had the fed buying bonds on a massive scale and you had the fed keeping interest rates at zero. And so, when you floor the car, you go fast, and it feels good. But you’re raising the risk of accidents, and that’s where we are now with inflation arousing so much concern.

ISAACSON: So, does that mean you fear that this new build back better reconciliation bill might have too much spending in it and it might exacerbate this problem?

SUMMERS: Walter, I’m supporting the bill. I think it could be improved in some ways I could describe but I’m supporting it. The spending in it, over 10 years, is smaller than last year’s spending was by a substantial margin. Moreover, unlike last year’s bill, the spending is financed with tax increases. Finally, this spending has substantial elements that will raise the supply potential of the economy that are investing in the country’s future. Whereas, the vast majority of the earlier spending represented transfer payments.

ISAACSON: One of the components of inflation right now is the employment cost index. Is that actually a good thing that maybe employment costs are going up?

SUMMERS: It’s good that workers are empowered, but when you see shortages of labor that are unsustainable. And as a consequence, you see shortages of products that lead to product price inflation, the truth is that during this period of employment cost indices, real wages have done less well than they have done in the proceeding years. It’s a little bit hard to tell because when you look at average wages, it’s all affected by who is getting jobs and who isn’t getting jobs. But the historical experience is certainly that turning economies into inflationary economies, as we did in the 1960s and 1970s, as has happened many, many times in Latin America, as happened in Britain, under progressive governments, inflation is not a friend of the middle class. You’re seeing that in the huge public response. We’re seeing to the inflation that we have generated.

ISAACSON: When I’m looking at inflation, one of the things I see is a 50 percent rise in things like gas prices, you know, gasoline prices at the pump, even probably home heating oil. Is that because of overstimulation that you’ve talked about or have we laid in so many regulations now that we’re getting a real problem with energy prices?

SUMMERS: I think it’s all of the above. It’s related to the stimulus. It’s related to the, as you say, to regulations. I think it’s probably even more related to the fact that over a long time period, Walter, there’s been a tendency in good times for the oil industry to over invest and then, to lose a lot of money when prices come down. And investors today are insisting that oil companies don’t do that. And that’s meaning less supply of oil. Of course, that’s reinforced by the whole anti-fossil fuel ESG movement. But I think there’s a fair amount that’s just coming from the economics. It’s also related to geopolitical developments in the Middle East and in other places.

ISAACSON: What do you think the probability is of a recession in the next two years?

SUMMERS: I think it’s probably a recession beginning in the next two years that we might not recognize at the time. I think it’s in the one-third to 40 percent range, given the rather delicate operation of containing inflation in which the fed is going to be engaged.

ISAACSON: And in order to prevent that, would you go back to a policy of looser money or even lower rates?

SUMMERS: I think you have to time things right and they’re going to find, they’re walking on a very narrow ledge and I just think we just have to hope that they get it right. I think we need to be prepared if we do find ourselves in recession, in a position to fiscally stimulate the economy and we’ll need — I hope that there are contingency plans somewhere in the government to be able to do that fairly rapidly. And — but I think that it’s a difficult balance. I also think that we need to be very careful about our situation in the financial markets. If you look at crypto, if you look at meme stocks, if you look at a variety of tech start-ups, if you look at things that are going on in some parts of the housing market, valuations look pretty elevated. That means there’s room for there to be a sharp decline. So, this is a moment when regulators need to be vigilant. People don’t make bad loans and in bad times. People make bad loans in good times. And this is a moment for everybody to be risk aware.

ISAACSON: You say you’re worried that we’re overheating the economy. What’s wrong with that? In a period like this with so uncertainty, shouldn’t we overheat the economy?

SUMMERS: The evidence is that when we say the economy is overheated, what we mean is that it’s on a path that is not sustainable. It’s on a path that’s going to lead to bubbles in financial markets. It’s on a path that’s going to lead not to higher inflation, but to constantly rising inflation. And then, you’re going to have to hit the brakes and that’s very difficult to do in a controlled way. And the people who are the greatest victims, when you do, are the people who are most concerned to try to help. This is the interest theory. This is the experience of what happened in the United States during the 1960s and 1970s. Culminating in the Volcker recession and the election of Ronald Reagan. This is what happened in Britain culminating in the election of Margaret Thatcher. This is a very extreme form, very different than what we’ve seen in the United States has been the fairly constant experience of Latin American populism. You spend and it feels good. But then, you create a variety of kinds of imbalances, debts, unsustainabilities and total paying is less. If I thought that we could maximize employment and workers incomes, on average over the next five to 10 years by overheating the economy, I would be for it. I’m not for overheating the economy because I think, ultimately, the consequences in terms of inflation and the response to inflation will work to hurt the people that are most in need of help. Many try to moralize this argument. This is not a moral argument any more than figuring out how to build a bridge so that it actually stays up is a moral argument with an engineer. This is an argument about how the system works and the path of overheating and enjoy it like the path of binging on chocolate cake is not a path that has had happy results historically.

ISAACSON: One of the problems is COVID and it’s been an international problem. Do you think we have the global mechanisms in place in order to fight pandemics like this?

SUMMERS: No, we are under resourced, we are underorganized and we’re under executing on a huge issue. One of the terrible things about Omicron in addition to all the consequences it’s going to have is that it teaches us that there’s a much wider range of mutations possible than we had previously imagined. The means, this could be with for really quite a long time. Keynes wrote a classic book about the period after World War I called “The Economic Consequences of the Peace,” about how Versailles set the stage for the Second World War. My fear is that somebody will write a book about this moment called “The Economic Consequences of the Dinner.” We should be committing far more resources than we currently are around this issue. We should be doing much more to organize the effective delivery of vaccines. We should be doing much more genomic surveillance all over the world so that when things come all we can catch them quickly. Testing two years in is still not widely enough available. And the various international groups that work on health care are still having turf fights. So, I would have to say this has not been the success of multilateralism that one might have hoped that it would be.

ISAACSON: Let me ask you just a broad philosophical question. People like yourself, and I’ll say people like me, for many years in the ’80s and ’90s bought into what I’ll call the Davos, Washington maybe Aspen Institute consensus that globalization was a great thing, that low tariffs were a good thing, that being able to outsource jobs was all right and that automation was good. And then, there’s been a populous backlash around the world against immigration, free trade, those type of things that may have increased the economy but hurt average people. Have you rethought that general support of globalization, low tariffs, free trade, immigration, automation?

SUMMERS: I think the broad directions are right. I think the broad directions have produced incredible improvements in standards of living for humanity, and that’s where the conversation needs to begin. Should there be a set of complementary policies alongside that probably were underemphasized? Yes, I certainly think there should be. I think the most important thing that Biden administration has successfully done in the last year was probably the global — certainly, in the international arena, was certainly its moves on global corporate tax cooperation that are important in a technical tax sense and raise revenue. But more fundamentally, stands to the principle that international negotiation can be for the interest of working people, not for the interests of those who gather in Davos. And in a whole set of regulatory areas, we’re going to need much more of that kind of international cooperation to make sure that global integration doesn’t come with global disintegration. But, Walter, I think there’s always a tendency to dissatisfaction. And I think if one looks at the historical record of populous nationalist policies, of (INAUDIBLE) policies to try to stop technology, that is a pretty dismal historical record. And so, to offer, as the antidote to globalization, some kind of populist anti-globalization, I think is a very dangerous mistake. To answer the credits with humane reform is, I think, the much better approach.

AMANPOUR: Professor Larry Summers, thank you so much for joining us.

SUMMERS: Thank you.