Larry Summers Predicts the Future, and It Doesn't Look Good

start with a little gloating. I mean, in any given year, economists get a lot wrong, and this year and especially large number of them wrongly assumed inflation was going to be a fleeting phenomenon. But you sounded the alarm early in the year, and we're considered a bit of a crank for doing so initially, but not anymore. What did you see that others didn't see? Definitely, you know, I've been right this year, but they've been plenty of years when I've been wrong. I did what I thought was

a straightforward analysis of the situation. I looked at how short incomes were of trend, and I saw that they were about twenty five or thirty billion dollars short of trend each month, and that that number was declining, and then I saw that the proposed transfer payments and other stimulus represented close to two hundred billion dollars a month, and so I thought, if you were filling a thirty billion dollar hole with two hundred billion dollars of spending,

there was likely to be some overflow, and that overflow would translate into inflation. I did the same calculation, essentially looking at g d P, and I saw a two or three percent GDP gap met with about fifteen percent of stimulus. I had thought a lot about the Obama period, and I agreed with the concern. Indeed, I expressed them at the time that that stimulus was too small. That stimulus and its first year was perhaps half of the g d P gap. This proposed stimulus was a significant

multiple of the GDP gap. I thought there was a case that the Obama stimulus might have been low by might have been low by it surely was not low by a factor of five to ten. So it seemed to me that we were over stimulating the economy. That people had not seen inflation in forty years, so they assumed it was something you didn't need to worry about, but that if you just did a straightforward analysis, demand was going to run ahead of supply. I have to say,

I think that's pretty much what we've seen. I don't think that the analyzes suggesting that this is all bottlenecks are right. Nine percent of CPI components show inflation above three percent, more than above the FEDS target. If I look at what's happening in the labor market, it looks to me like we've got substantial labor shortages that push wages up, but only with a lag, because wages aren't

reset constantly. We've got substantial pressures in the housing market that have not manifest themselves at all really in the official price in disease UH yet, So I think we've got a fairly serious inflationary situation that's been growing for quite some time. If wages do go up, and it's true that we haven't seen as much as you might have expected in the last few months, but if they if they do go up, the last twenty years, we haven't seen a follow through from higher wages to higher inflation.

Even in the Fed Zone model doesn't include much response from inflation. So why do you think this time will be different? Well, there are two different questions. One is the response of prices to wages, and the other is the responsive wages to unemployment. With respect to wages to prices, we just haven't seen very much variation in UH the level of wage growth, and therefore it would be hard

to find a relationship with prices. I'm much more influenced by the experience of my own talking to businesses and even more people like those Bloomberg employees who spend their lives talking to companies, and they all say more or less the same thing. We're gonna have to push up wages because of labor shortages, and when we do, we have plenty of pricing power. And I guess I trust those anecdotes more than I trust econometric relationships estimated over

periods when there's been very little variation. We did have some months in with low unemployment and not extremely rapid wage pressure, but that's one several month experience in twenty years. I don't think there's any support in the data for the view the FED took that the economy can enjoy three and a half percent unemployment for multiple years with significantly declining UH inflation. Indeed, the FEDS forecasts call for unemployment below its estimates of the normal level interest rates

never reaching in the next few years. It's uncept of the normal level and nonetheless continuous deceleration of inflation that might happen, but it doesn't seem to me that it is the most in joyitive reading of our macroeconomic history.

Just to follow up briefly on the on the wages and prices thing, you're you're obviously right that that companies have been complaining about labor shortages, have been talking archly about rising costs, meaning they were going to have to push up prices, and they clearly do have pricing power. All the data that we've looked at, and we discussed it on the on the podcast a few weeks ago suggested that they've already used that power to raise profit

margins this year, well beyond any increasing costs. And it's not obvious that they couldn't absorb some of this increase wages in profit margins. I mean, inherently that wouldn't be such a bad thing, right if you had more wages for workers and companies absorbed some of it in profit margins, which in some cases are historically high. You know, Stephanie, prices are set by supply and demand, and we're seeing

in a very wide range of sectors rising demand. For example, retailers are engaged, apparently, is best one can tell from the anecdotes, in much less promotional activity this Christmas than they have been in previous Christmas. That's showing up in higher margins for them and for their suppliers. I don't think there's anything nefarious about that. That's just what goes with an economy where UH stores are stores are full. Um.

I don't know that, you know. I think the diagnosis that you're implicitly offering is the one that the Nixon administration rather unsuccessfully offered, that rising prices necessitate price controls so as to contain profits and reduce inflation. That worked out rather spectacularly badly, and fortunately that's not an idea

we've heard this time around. I think trying to restrict prices would be the best way I could imagine two lengthen the period of shortages, UH bottlenecks, and disillusion me. We tried that strategy with respect to gasoline in the late nineties seventies. I don't know why businesses would not be pushing on prices when they had shortages of goods and supply. I guess well, I'm tripping up over is

that you've written quite a lot in the past. An important academic is actually about the decline in labor bargaining power and the impact that this had had, and that particularly how the scales had shifted in favor of employers in many parts of the labor market. Um, it just sort of feels in the analysis that you're giving. I don't recall you accuse me of proposing price controls. I don't recall ever saying that, but I'll check the transcript.

But the description you're giving suggests there is no way to reset that balance or perhaps even in the sort of macro terms, start having a higher share of national income going to labor relative to capital, you know, reversal of what we've had in the last few years. Because if if wages go up faster than productivity, you're saying the FED should definitely put on the brakes in response to that, and if it doesn't, companies will inevitably just pass on any wage increase and it will just result

in more and more inflation. It doesn't feel like there's any way to reverse that psycho we've seen over the last few decades. That's that's really not what I'm saying, Stephanie. I mean, first, just on the facts. This period of high inflation has coincided with more rapid reel wage reduction than we had seen previously. So for the majority of workers, it's working out badly so far, not working out well.

That's a political response to inflation that we're observing. Second, I am a strong supporter of the type of labor law reforms that the administration has worked on. My colleague in the labor power paper that you wrote referred to Anna Stansbury, has done very important work showing that when you put reasonable penalties on it influences behavior and allows

union organizing to take place. I am a strong supporter of measures to strengthen labor through UH, the labor movement in unions, through a range of innovations that would encourage labor power. What I don't agree with is UH the idea that's simply running the economy hot on an unlimited basis can do it. If I thought we could sustainably run the economy in a red hot way, that would be a wonderful thing. But the consequence, and this is

the excruciating lesson we learned in the nine seventies. Consequence of an overheating economy is not merely elevated inflation, but constantly rising inflation. And that's why my fear is that we are already reaching a point where it will be challenging to reduce inflation without giving rise to recession. Should

we do all kinds of things. Should we raise a minimum wage, absolutely, Should we empower unions, yes, but this kind of policy, there are no examples of successful inflationary policy that has worked out to the benefit of workers. And there are dozens of examples, from the Labor Party in Britain in the nineties seventies to multiple Latin American experiences to our own experience in UH the nineteen sixties and seventies, where it backfired with respect to the very

people it was trying to help. Do you think biden nomics deserves a dictionary entry or will deserve a dictionary entry when the dictionaries get rewritten or revised? Does it does it amount to anything in your view? I mean, we've had any twelve months. I think we'll have to see what happens down down the road. UH. The hope would be that it represents a kind of progressive supply

side economics that emphasizes supply and does so through public investment. Unfortunately, the share of the spending that represents transfer payments rather than public investment has been sufficiently high that I'm not sure how great the benefits will be, and I'm concerned that there's been insufficient incent impulse to making the public

investments uh cost effective, streamlining infrastructure investment, for example. On the other hand, Uh, Stephanie, I think that the recognition that we have On the one hand, on your flight, you can now watch television in the seat in front of you in a way that would have been inconceivable thirty years ago. On the other hand, it takes half an hour more to get from Boston to Washington than it did thirty years ago, just because of the decaying infrastructure.

That's a kind of misplaced priority, and it's a metaphor for what's going wrong, um, in important parts of the way our economic system has functioned. I mean, I've known you for a long time and through a lot of that time, and certainly when you and I were the

Treasury Department in the late nineties. The kind of default view of most government government governments was that government should meddle as little as possible in mark and set the rules for markets, but then let the chips fall where they may, especially on trade, um and potentially the environment, industrial policy, all those things we tended to be a sort of default was to be suspicious of these things. Um, do you have you had a change of heart on

those things? I mean, I notice notice that Janet Yellen recently talked about needing to be less reliant on other countries for critical goods. And I've seen you have talked a bit about in the environment of wanting a more sort of muscular approach to government. Are you Are you rethinking your view of government. I think that there's been

this extraordinary change in relative prices stuff. Um, if you look at the relative price of the day in a hospital and a television set, it's changed by a factor of a hundred since the night. That means we're in a very different economy and a much larger share of the economy, a much larger share of the people working ari in sectors that have a range of market face years.

And certainly there's a case for government involvement in those But I think what needs to be very very careful about how governments will carry out any kind of industrial policy intervention. And I have to say that when I hear about in industrial policy in the name of achieving green objectives, I'm much more sympathetic, for example, than when I hear about it in the name of preserving jobs.

I think the available evidence on protectionist strategies is that they mostly cost a million dollars a job saved or more once you work through their full UH impacts. Take for example, UH steal protection. UH steal textion operates to save potentially fifty tho jobs of steel workers, sixth as many as we have manicurists in the United States, but it makes industries with five million people that you steal

less competitive than the otherwise would be. Going back to the Janet yelling comments, a lot of people look at the supply chain snarl ups, the lines of container ships outside Long Beach and other big ports and say Donald Trump was right, we should be less reliant on all these foreign manufacturers. It's important to understand why we have those supplies, why we have those long lines. It is

not because of anything that China is doing. It is because our demand for goods searched and I would much rather see us be better at expanding port capacity quickly. Do we need to pay attention to rare earths and other goods that are highly concentrated in the world for our national security? Yes, we do. Should we institute some broader program of non reliance on trade, I suspect there

would be very substantial inefficiencies from doing that. I do think we need to manage the global economy much more than we have. That's why I was such a strong supporter of the initiatives that Secretary yell And brought to completion to harmonize corporate taxes around the world so capital could run, but it couldn't hide and would be taxed in uh reasonable ways. That's why I think the right trade agreements pay attention also to the context in which

trade takes place. What kind to regulations, uh there are? What kinds of rules there are for workers? What kind of exchange rate arrangements? Uh there are? But I think a strategy of actively pursuing disintegration is not likely to make us more secure. And certainly the first order effect of stopping us from buying goods from abroad when they are cheapest will be to exacerbate inflation rather than to

reduce inflation. So the idea of cutting off cheap supply as a strategy for reducing inflation at a moment when that's our principal economic problem seems to short run economic problem seems to me bizarre at two very quick ones. Because you mentioned trade. One of the areas where President Biden has been probably most similar to his predecessor is in relations to China, um general attitude to China. Do you basically agree with that? I think we have not

yet formulated a satisfactory China strategy. I don't think President Trump had one. I think two of the struculence is very risky, and we have had a lot of that. I hope we'll see evolution in the months ahead. Just going back to what we were talking about the beginning, and you you painted a picture where you thought it was much more likely than not that we were ending a period. But we're starting a period that was going to be quite hard to control inflation, and inflation could

continue for some time. You know, people will remember for many years you were talking about secular stagnation. If you look at the bond market, very low interest rates still out into the long term future. There's the suggestions meems to be from them that secular stagnation is still here, that we still have structurally low growth prospects. How is do you still believe in secular stagnation? Do you now believe in secular stagflation? I think secular stagnations are real

risk looking out a few years. I certainly think that's what the market is, as you say, Stephanie, pricing in I'm surprised by how low long term interest rates are. That's something I didn't get right. I would have forecast larger increases in interest rates given conditions. I think part of it is that markets are foreseeing that we will do what's necessary to contain inflation, and that process will be quite contractionary, and that's part of what I think

is being factored into the level of markets. But I do think there's a real chance that there will be a return to secular stagnation. I'm not sure you know. In some ways, Stephanie, this current episode of a very large infusion of spending brings back memories of World War Two, and there was an expectation that after World War Two the economy would return to the kind of secular stagnation depression that it had been and for a variety of

reasons that never materialized. I'm really not sure what's going to come after uh this current episode. I'm certainly not confident that we're going to have sustained excess demand for many years. I think the challenges that we've pumped up aggregate demand now and then who knows how we're going to work our way through back to more normal levels of demand. Well, you've paid it a pretty worrying picture for the next year, for twenty two. So I kind of hope for all our sakes that you're more wrong

next year than you were this year. But I hope you have a happy new year. And thank you very much, Larry something, thank you. And that is it for this special episode of Stephanomics. We'll be back next week with a special look ahead to two. In the meantime, enjoy your holidays if you get any, and follow at Economics on Twitter if you feel like escaping into news and analysis from Bloomberg Economics. This episode was produced, as ever by A Mangus Henrickson, with special thanks to Larry Summers,

Kelly Friendly and Julie Shampoo. Mike sasso Is executive producer of Stephonomics and the head of Bloomberg Podcast is francesco Leavie.