A 1970s-style financial crisis will hit the US economy if the Fed lets up in its inflation fight, according to Larry Summers.
The former Treasury Secretary criticized recent calls to raise the inflation target from 2%.
That could cause inflation to spiral out of control, he said, warning of “spectacular” consequences.
The economy could be slammed with a 1970s-style financial crisis if the Federal Reserve abandons its inflation target and lets prices run higher, according to former Treasury Secretary Larry Summers.
At a panel discussion at the World Economic Forum, Summers rebuked suggestions from some economists that the Fed should lift its inflation target from its long-standing 2% target to 3%-4%.
“To suppose that some kind of relenting on an inflation target will be a salvation would be a costly error, it would ultimately have adverse effect as it did in a spectacular way during the 1970s,” Summers said, referring to the stagflation crisis that gripped the economy nearly half a century ago. Inflation expectations spiraled out of control, prompting the Fed to embark on an aggressive monetary tightening campaign that caused a severe recession in the early 1980s.
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Other economists have warned that the US could risk a similar crisis if inflation isn’t brought under control. That’s because central bankers have aggressively tightened interest rates in response to rising prices, but inflation still remains well-above the Fed’s target, clocking in at 6.5% in December. And rates are already approaching levels that could overtighten the economy into a downturn, experts warn.
Economist Mohamed El Erian is among those that have suggested the Fed may have to revise its inflation target to 3%-4%, though the Fed has reiterated its commitment to its original 2% goal. That could be because central bankers are trying to maintain their authority on inflation, after mistakenly calling rising prices “transitory” in 2021, Summers said.
“It would be a grave error for central banks to revise their inflation target upwards at this point. Having failed to attain the 2% target and having re-emphasized repeatedly the commitment to 2%, to then abandon the target would do very substantial damage to credibility,” Summers said, adding that recession would be inevitable if inflation is not properly controlled.
Summers has revised his economic outlook multiple times, and recently said he believed a soft-landing was becoming more likely, despite previously warning of an imminent recession and a new era of volatility. He reassessed the likelihood of an incoming recession due to moderating inflation figures, with the Consumer Price Index down over 250-basis-points from a 41-year-high in 2022.