Summers warns Fed of 1970s-style mistake with CPI set to slow

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(Bloomberg) – Former Treasury Secretary Lawrence Summers said he fears a slowdown in headline inflation in the upcoming data could cause the Federal Reserve to conclude that its policies are working, when many more action is in fact necessary.

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“I’m afraid we have some good news on non-core inflation,” Summers said on Bloomberg Television’s “Wall Street Week” with David Westin, ahead of Wednesday’s consumer price data expected to be released. show a retreat in inflation, thanks in particular to a fall in the price of gasoline. Combined with some signs of an economic slowdown, the danger is that this will “lead the Fed to think things are under control.”

The U.S. economy, however, remains in an “overheated” state, as July jobs and payrolls figures released on Friday showed, Summers said. A “red-hot” labor market will mean “constant, even accelerating inflation”, he said.

Payrolls jumped 528,000 in July, a broad gain that beat all estimates and was the largest in five months, Labor Department data showed Friday.

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“Everything about that number tells me overheating, not yet under control, not yet close to being under control,” said Summers, a Harvard University professor and paid contributor to Bloomberg TV. “My concern was actually magnified,” he said.

Summers pointed out that his former economics intellectual partner, Nobel laureate Paul Krugman, also warned that it was not time for the Fed to change course. Fed policymakers have raised rates by 75 basis points at each of the past two meetings, in the most aggressive tightening since the 1980s.

Krugman wrote earlier in The New York Times that “the good news we are about to get on near-term inflation is not proof that the strategy has ever worked, and alas (I am generally a monetary dove), it offers no justification for an easier pivot to money.

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Summers said the danger is that “we’re going to have a situation like we had in the 1970s, where we perpetuated inflation by not doing enough to contain it.”

Excluding food and commodities such as energy, “we have, by any reasonable measure, core inflation somewhere in plus or minus 5%,” Summers said. “It’s more than when Richard Nixon implemented price controls. It’s not acceptable by any dimension.

The former Treasury chief reiterated his criticism of Fed Chairman Jerome Powell’s assessment last month that, with the latest interest rate hike, the central bank had already reached a “neutral” setting – where it neither fuels nor restricts consumer prices.

“I don’t think the Fed has the wire right now,” Summers said. Without significantly raising real interest rates – which are adjusted for some measure of inflation – “then we are just setting the stage for stagflation,” he said.