Summers warns the Fed of a 1970s-style fallacy when the CPI is set to slow

Former Treasury Secretary Lawrence Summers said he was concerned that slowing headline inflation in the forthcoming data would lead the Federal Reserve to conclude that its policies were working when in fact much more was needed.

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(Bloomberg) – Former Treasury Secretary Lawrence Summers said he was concerned that slowing headline inflation in the forthcoming data would lead the Federal Reserve to conclude that its policies were working when in fact much more action was needed.

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“I’m afraid we’ll see some good news on non-core inflation,” Summers told Bloomberg’s Wall Street Week with David Westin ahead of Wednesday’s consumer price data set to show a retreat to inflation, especially thanks to falling costs gasoline. Coupled with some signs of an economic downturn, there is a danger that “this will lead you to think the Fed will think everything is under control.”

However, the US economy remains “overheated,” as the July employment and wage data released on Friday showed, Summers said. The “red-hot” labor market will mean “constant and even accelerating inflation,” he said.

Wages jumped by 528,000 in July, a big increase that outstripped all estimates and was the highest in five months, according to data from the Labor Department on Friday.

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“Everything about that tells me about overheating, not yet under control, not yet on the way to being under control,” said Summers, a Harvard professor and paid associate at Bloomberg TV. “My concern was actually heightened,” he said.

Summers stressed that his erstwhile intellectual sparring partner in economics, Nobel laureate Paul Krugman, also warned that the Fed should not change course. Fed policymakers raised interest rates by 75 basis points at each of the last two meetings, in the most aggressive tightening since the 1980s.

Krugman previously wrote in the New York Times that “the good news we are about to receive about short-term inflation is not evidence that the strategy has already worked, and unfortunately (I’m usually a money pigeon), it offers no justification for a shift towards easier money.” .

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Summers said the danger is that “we will have a situation similar to that in the 1970s where we fixed inflation without doing enough to contain it.”

By shedding food and commodities like energy, “by any sane measure of core inflation, we are at plus or minus 5%,” Summers said. “This is more than when Richard Nixon introduced price controls. This is unacceptable in any way. “

The former treasury chief again criticized last month’s Fed chairman Jerome Powell’s assessment that the central bank has now reached a “neutral” setting following the recent rate hike – where it is neither stoking nor curbing consumer prices.

“I don’t think the Fed has a thread right now,” Summers said. Without a significant increase in real interest rates – which are adjusted for a certain rate of inflation – “then we just prepare the ground for stagflation,” he said.

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