Summers Predicts U.S. Recession More Likely Than a Soft Landing

and of course inflation. Larry was one of the first to predict You'll remember over a year ago the surge in prices were now living through. Now the US Federal Reserve, the Central Bank has belatedly accepted that interest rates will need to go up quickly and often to get control of prices, which in turn has some people worried about the future of the recovery. So I started by asking Larry whether he believed that the recession in the US was now inevitable. I think it's the most likely thing.

If you look at history, there has never been a moment when inflation was above four and unemployment was below five. When we did not have a recession within the next two years. So I think the odds are a hard landing within the next two years are certainly better than half, and quite possibly two thirds or more. I don't think the idea that is still embodied in FED forecasts that we could have continuing super tight labor markets at three and a half percent unemployment and we could have inflation

come down rapidly is a terribly plausible one. That's a resident two of team transitory. And the key fact one has to recognize, I think to grasp the current situation is that wage inflation is now running above six percent on the best data, which is the Atlanta FED indicator. And if wage inflation is running at six percent, that's a kind of ultimate core inflation, pointing to price inflation

at four and a half or five. So I think we're either gonna live with that for quite a while, in which case we'll have an even bigger recession later, or some set of events involving monetary policy and involving what happens in the real economy are going to force a hard landing. I'm much more agnostic on how high interest rates are going to have to go to generate

a hard landing and disinflation. Then I am on the likelihood that at the end of the day we're gonna see a fairly hard land Just to dig in a little bit in terms of what you think the mechanism is going to be that will bring the US into a recession, I mean, we we know, and in fact was part of your argument that the stimulus that was so large a year ago in the US, it left household excess savings quite high, certainly by historical standards, even

in the lower half of the income distribution UM Debt service from households is now at a forty year low. They are looking they're coming into this with quite a strong position, even with the inflation that we're seeing. So so, what is the mechanism that's going to bring the US into a recession? I think the two two classes of mechanisms that are operative, and which one is going to get their first and their relative timing is something where

I don't have a confident judgment. One class of mechanisms is monetary policy. I think monetary policy is going to have to keep going until we see disinflation, and we're not going to see disinflation back towards the target range until we see unemployment rise meaningfully. That's one source of

uncertainty monetary policy doing what it has to do. The other is the countervailing mechanisms to what you described, the fact that inflation has eroded real incomes and the value of savings, the fact that there's significant fragility in financial markets, the fact that mortgage rates have drought have risen by two hundred basis points in UH the last four months, and we're seeing for the first time in many years that lots of people are starting the mortgage process and

not finishing the mortgage process. We're seeing evidence in certain sectors of significantly reduced traffic. So I think it's hard to know when, when, and to what extent the economy is going to turn over itself, and to what extent it is going to be induced by monetary policy. But I think the judgment it's hard to escape is that inflation is not going to get near reasonable levels if

the economy doesn't at least substantially slow. You talk about potentially the need or necessity of unemployment to go up. Some of your critics would say, we've got to an amazing point in the US economy in which US workers have been on the back foot for so long that you have the unemployment rate that there's previously unheard of

three point six percent. We've got reported in Indiana where there's less than one unemployment and workers in those places have a position of power that they haven't had in many years. What is wrong with having produced that situation? Look, Stephanie, it's a it's a hugely important question. The first academic work I did was on how important hype high pressure

labor markets were for the disadvantage. I showed what was novel at that moment, that a one percent increase in the employment ratio for white men was associated with a six percent increase in the employment ratio for African American teenagers. So I yield to no one in my belief in the importance of helping the disadvantaged and in recognizing that tight labor markets do benefit uh those who are action

lee left behind. But the three problems. The first is that overall this higher inflation has gone with falling, not increasing real wages. You know, if you look at a graph of the nominal wage growth in the United States on one axis, and real wage growth growth and purchasing power on the other axis, it looks like a turned over parabola. Living standards grow most rapidly with wages arising at four percent, and then they fall off as you start to see wage growth at five, six, seven, eight percent.

So the first thing to say is that what we're doing is uh we're having lower real wage growth for the vast majority of the populations and consequences. The second is the core lesson we have learned is that there's not a stable trade off between unemployment and inflation. There's a stable trade off between unemployment and the acceleration of inflation. And if we run an overheated economy, it's not that

we'll have to live with four percent inflation forever. It's that will live with steadily rising inflation and set up at ever greater price that we have to pay. Prudent policy makers don't just pay attention to the current moment. They pay attention to what happens over the longer term. And the consequence of overheating is that it has to

be followed by something that ultimately stabilizes things. And the history is that if you look at the overall path, the poor are worse off once you go through that whole process, then they would have been if you kept things stay bole all along. That's why the fed's new woke rhetoric in was so dangerously misguided. And I fear that down the road, the people who they were most concerned to help with that rhetoric are going to be the victims if, as I expect, we have some kind

of hard landing. Even that you've started by saying you think that's the most likely scenario and that you want the FED to be looking down the track, I guess the other inevitable question is how do you think they should be responding to a recession. I think the FED has to stay focused on bringing down the inflation rate and bringing down the expected inflation rate. I don't think there is any alternative that doesn't set a stage for

greater pain. We can have an argument about two versus some number a bit greater UH than UH two, But I think we need to recognize the think about this, frankly in the old fashioned way, which is less in terms of numerical targets, and that is price stability is when people aren't talking all the time and focused on the overall changes in the price level. By that definition, we had about thirty five years of price stability between the mid eighties and and by that definition, we have

lost price stability in the United States. UH. Inflation is now the number one economic issue. It's driving vast erosion in confidence in government, and the FED has to do what's necessary to restore a sense of price stability. I can't say exactly what that means in numerical terms, but I know that we are well away from it UH now in the judgment of the American UH people, I

think that's what's going to be necessary. UH. In terms of UH monetary policy, I welcome the particularly the most recent speech of Chairman Powell, which I think UH moved a long way towards being in the right place. I'd like to see the FED signal a commitment to raise interest rates until real rates are clearly positive, or until it's clear that price to reality has been restored. And I think they've moved a long way in that direction. That's good of late, but I think they've got UH

some distance to go before they achieve it. It has become an extraordinarily salient issue politically inflation. I mean President Biden did in his State of the Union he had said this is going to be his number one goal or one one of his primary objectives in the next year and beyond bringing down inflation. And I think some of us were left sort of scratching our heads, thinking, we'll hang on, what can the administration do? Since it's the FED job to be reducing inflation? What can the

administration do to reduce inflation? Look the net effect of the things the administration talks about in terms of micro policies to reduce inflation, this gouging talk is frivolous, non serious, and utterly ineffectual. A guest price holiday would ultimately push up prices uh by raising demand. The student loan relief yesterday is injecting resources into the economy at a hundred billion dollar a year annual rate when the economy needs

to be cooled off uh not uh heated up. The administration could be much more constructive than it has been with respect to energy supply. So I don't think the administrations by America policies operate in the direction of raising prices, as do various policies they pursue to raise small business. So the micro economic policies of the administration are have been a wash with respect to inflation at best, what could they do? UH? The Peterson Institute just released a

study that I helped instigate and discussed. It's on their website that estimates that a realistic program of trade liberalization could take one point three off the cp I. Their scope for regulates for UH policies to increase immigration that we take substantial pressures off the labor market. But the approaches UH that would work, our approaches that would emphasize UM increasing the level of competition for American producers, not

seeking to protect American producers. That's the that's the element U of micro economic policy that has a prospect for success. And I fear that the more popular themes around corporate gouging and the like are simply diversionary. The FED had one job. It is monumentally failed on that job on a consistent way for the last year and potentially into the future with this strategy. If a fund made manager made that kind of bad call for such a long time,

there would be pretty concrete consequences. If an elected politician made that kind of mistake, they would almost certainly be consequences. Do you do you think there should be greater accountability for this particular failure and potentially for the forecasting system that produced it, but even potentially individuals. I I think the FED should be much more visibly acknowledging that it's been wrong and seeking to understand and learn from its

errors than have been UH the case. And I think the failure for there to be some institutional review, you know, after bad battles, armies have after action reviews. The I m F has blundered in various situations, and there have been very thoughtful reviews of what in its culture and what in its mode led to those errors, and I think the FED should be engaged in more of that.

I think, in fairness to the FED UM, the views they were expressing were relatively close two UH consensus views, not frankly this last fall, when I think they were behind the consensus and still sticking with their views, But for much of last year their views were tracking consensus views. And so I think the soul searching is less about accountable individuals at the FED, and then about how those

consensus views UH were formed. And I guess I have been struck by a certain UH blitheness with which some of my UH friends in the economics community have kind of pivoted two addressing the current moment without thinking about what led them to be wrong in the past. Okay, let's let's um, let's get onto Ukraine, Russia and the

fallout from the crisis. You were a senior Treasury official throughout those two Clinton administrations in the nineties, which were really kind of trying to think through after the end of the Cold War, how Russia was going to fit into the international economic system, decisions around whether it should join the G seven, all of those things. Should we

be doing more to hurt Russia economically? Now? What what's your take on the kind of coordinated sanctions that have that have been achieved and the other actions that have been taken. I think by the standards of history and tradition, we've done a great deal. By the standards of the magnitude of the problem, there's a lot more to do. Understand this. The ruble is now trading at the same exchange rate that it was before the war started. Russian

banks are not experiencing runs every day. Russia is getting revenues from the export of its energy products that are comparable to or greater than they were receiving before the war. Because of increased energy prices, the limitation on the sale of goods to Russia has not been nearly as comprehensive as was imposed on Iran at earlier UH moments. The truth is that, in a sense, and I strongly support this, using economic tools is trying to fight a war without

costs and blood. That is the right thing, But in important respects, we've been trying to fight an economic war without costs two households from the first moment when the sanctions were introduced, and as it was explained that simultaneously we're gonna be doing everything we could to keep guest prices under control, I have felt that there was a

moral failure. And if this is a unique and extraordinary worst threat in seventy years of naked aggression, then we need to be prepared to make sacrifices at the level of accepting higher energy prices, wearing sweaters on days with cool weather being a little hotter when UH we can't run air conditioners as strongly as we did before, sacrificing luxury exports UH to UH Russia, and sacrificing mercantile UH commercial UH interests. I do not believe that enough has

been done. I believe that much more needs to be done. I was glad to see the step that was taken to stop the Russians from using their froe and reserves to pay debt, but in a way, it was an extraordinary and remarkable thing that for the six previous weeks they had been allowed to use their frozen reserves to

prevent them UH from doing it. So I think that we have a long way to go in raising the pressure that we impose on sanctions, and frankly, I would prefer less rhetoric about the war criminality of what's going on, which it seems to me does not bring pressure to produce peace, if anything, slightly the opposite, by meaning that there's no exit strategy from this, less emphasis on that rhetoric, and much more emphasis on the imposition of UH economic pain we saw in the United States in two thousand

and eight. What cascading lack of confidence in finance can do to destroy the performance of an economy. It's extraordinarily counterintuitive for any financial person, but I think we need to engage exactly those forces as forces of destruction with respect to the Russian economy right now. Recognizing that that may have some collateral implications for some few financial institutions in the West and being provided being prepared to provide

the necessary UH kind of support. But I don't think we have yet stepped up fully in terms of engaging the tools of UH financial warfare. That's how I see it from UH the outside. But what I have is an outsider's view, and I've been an insider, and I have seen outsiders with naive views making it sound simpler than it is. And in fairness to those who are making the decisions, it may be that there are a whole set of collateral costs that they have thought through

very carefully. But my instinct is that there's a good deal more that could be done, and I'd like to see some long queues outside some Russian financial institutions. I'd like to see some Russian defaults followed by the seizures of key Russian assets, and I'd like to see the ruble in free fall as part of judging the efficacy

of a sactions program. You know, one of the other things that happened UM and that your watch the Treasury when we're working together in the late ninety nineties was the beginnings of the g twenty, which was pretty evident in the global financial crisis in the global response to that, but has been pretty absent in recent years, and certainly in response to this crisis, or indeed the inflation crisis that's now and cost of living crunch that's coming for

so many countries. Um, I wonder, do you think it's the end of the G twenty. Look, I think the G twenty had a premise. The premise of the G twenty was that all countries wanted all other countries to do better, that we all gained from a more open, more rapidly growing economy, That the United States wanted China to grow faster, that China wanted the US to grow faster, That we all wanted to solve global problems together. And

that was the premise of the G twenty. And that was basically true in the two thousand and eight financial crisis. Everybody wanted the crisis to be successfully weathered and the global economy to grow again. That is in very profound questions today. Self Evidently, it is not the objective of the other member, most of the other members of the

G twenty to support Russia's economic flourishing. It is a substantial question whether we are hoping for the success of the Chinese economy and whether China is hoping for the success of our of our economy. So the premise of the G twenty, which was a forum for devising means

to shared ends, is much less evidently true today. And before one talks about what you should convene a G twenty meeting to do and what kind of statement G twenty should make, it seems to me one has to get straight these questions about which communities have which shared ends.

Right now, I perceive a bit of a vacuum in clear thinking on the is with some traditionalists wanting to just kind of keep going with the G twenty and have do stuff, and others have what seemed to me to be rather naive given the world we live in, conceptions of communities of democracy, which it seems to me do so much to exclude so many major stakeholders in the economic system that there's a real question as to

whether they can be meaningfully affective. So I think we need some serious reflection on the mechanisms of international fora and consultation. I don't know that we're in the right place right now, but I think it takes a kind of realism that balances sort of two cliches. Uh one, some sharing of ends is a prerequisite to successful cooperation, and the other is you don't make peace with your friends,

you make peace with your potential adversaries. And so I suspect we need to use the European term some kind of variable architecture, in which there are some faora where there's more in common among the participants but less reach, and other foura in which there is less in common among the participants but more uh reach. Anyone who thinks that these descriptions and that these kinds of issues and this is a place where I've gone from naive and

stupid to less naive and stupid. I used to think that serious people discuss serious things, and diplomats discussed the shape of tables. And I think I've now come to realize how important the shape and composition of groups could be. And anyone who doubted that proposition needs to consider how consequential the rather loose statements that were made about allowing Ukraine into NATO UM proved to be in terms of

what they set off. Larry Thomas, thanks very much for an excellent exchange on issues that I may will be of great interest to all the people listening in. Thank you, Stephanie. Well that's it for this episode. Thanks for listening. We'll have more from around the world next week and in the meantime, remember you can always find us on the Bloomberg Terminal, website, app or wherever you get your podcasts, and for more news and analysis from Bloomberg Economics, follow

our Economics on Twitter. This episode was produced by Magnus Henrickson, with special thanks to Sommer Sadi, Larry Summers, and the Council on Foreign Relations in New York. Mike Sasso is the executive producer of Stephanomics and the head of Bloomberg Podcast is Francesca Levy m