More food for thought from Larry Summers.
https://www.washingtonpost.com/opinions/2022/03/15/fed-powell-fight-inflation-interest-rate-hike/
When the long-awaited process of raising interest rates begins Wednesday, market observers will fixate on the precise words used in the Fed statement and during Chair Jerome H. Powell’s news conference. The focus will be on what they signal about the number of rate increases coming this year and next, as well as the schedule for selling down the bonds the Fed accumulated during the pandemic.
The hope is that the Fed can engineer the proverbial soft landing, whereby inflation returns to around its 2 percent goal and the economy remains strong without a substantial increase in unemployment. Judging by their statements to date, Powell and his colleagues seem to believe they have a good chance of success.
Anything is possible, and wishful thinking can sometimes prove self-fulfilling. But I believe the Fed has not internalized the magnitude of its errors over the past year, is operating with an inappropriate and dangerous framework, and needs to take far stronger action to support price stability than appears likely. The Fed’s current policy trajectory is likely to lead to stagflation, with average unemployment and inflation both averaging over 5 percent over the next few years — and ultimately to a major recession.
Indeed, recent research that I conducted with my Harvard colleague Alex Domash shows that overheating conditions of high inflation and low unemployment are usually followed, in short order, by recession.
A year ago, the Fed thought inflation would be in the 2 percent range for the next year. Six months ago, it was expressing optimism that inflation was transitory. Two weeks ago, it was still buying mortgage-backed securities even as house prices had increased by more than 20 percent. No explanation has been offered for these rather momentous errors. Nor is there any suggestion that the Fed forecasting procedures or the personnel that produced them will change. Indeed, the most important change in the March Monetary Policy Report to Congress was in the wrong direction — the removal of the discussion of the various monetary policy rules that had suggested policy was dangerously loose.
So there is little basis for confidence in the Fed’s assessment of inflation risks. With extraordinarily tight labor markets getting tighter by the best available measures, and wage inflation running at 6 percent and accelerating, high inflation was a major risk even before the events of recent weeks. We now face major new inflation pressures from higher energy prices, sharp run-ups in grain prices due to the Ukraine war, and potentially many more supply-chain interruptions as covid-19 forces lockdowns in China. It would not be surprising if these factors added three percentage points to inflation in 2022. And with price increases outstripping wage increases, a wage-price spiral is a major risk.
