Former Treasury Larry Summers has concerns about President Joe Biden’s coronavirus relief plan, which he broadcast in a Washington Post op-ed on Thursday. Specifically, he thinks it might be too big. Too much. Just, you know, a bit extra. “While the arguments for providing relief to those hurt by the economic fallout of the pandemic, investing in controlling the virus and supporting consumer demand are compelling, much of the policy discussion has not fully reckoned with the magnitude of what is being debated.”
I’ve already touched on why I don’t think we should take Summers’ worries too seriously. But I want to discuss it a little more at length, because apparently his op-ed is getting passed around the White House right now, which suggests his thinking could genuinely have an impact.
Summers writes that “policymakers need to ensure that they have plans in place to address two possible, and quite serious, problems.” One is largely political, while the other is economic.
We don’t need to belabor the political bit: Summers is worried that if the U.S. spends more than is necessary on relief, then politicians might be less inclined to pour resources into important long-term priorities like infrastructure and green energy. That’s a fair concern for someone like Senate Majority Leader Chuck Schumer to keep in mind while taking the pulse of his caucus, and if it turns out that Sens. Joe Manchin or Kyrsten Sinema have a hard dollar cap on what they’re willing to add to the deficit, he should probably be careful about prioritizing. In a political world of finite resources, it may well be that, in the end, some of the money currently earmarked for states or schools would actually be better used for a climate plan.
The main economic issue Summers raises is that Biden’s proposal is so immense that it could lead to a problematic amount of inflation. “While there are enormous uncertainties,“ he writes, “there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.”
This might strike a lot of readers who casually keep up with economic news as a little odd. After all, the U.S. has suffered from chronically low inflation ever since the Great Recession—with the Federal Reserve consistently failing to reach its annual target of 2 percent per year. That has left us in a precarious position in which every time growth looks a little weak, policymakers have to start worrying about whether we might stumble into deflation, which can become a vicious trap where falling prices grind economic activity ever slower. It’s been such a concern that, prior to the pandemic, the central bank decided to shift its entire framework for thinking about monetary policy, partly in order to see if it could consistently nudge inflation a little bit higher and closer to its goal.
So why is Summers fretting about inflation now? The short answer is that some economists think that Biden’s relief plan is actually bigger than the economy’s “output gap”—essentially how big the economy would be if it were firing on all cylinders vs. how big it is now thanks to the coronavirus recession. As a result, some people think it could actually send the economy into an unsustainable state of overdrive: Businesses will run out of new workers to hire, companies will run up against the limits of their capacity to produce new stuff, and as a result the flood of government spending will push up prices. Presto, inflation.
One issue with this argument, which I got into on Thursday, is that nobody really knows what the output gap is, in part because it’s been so long since the economy was revved to capacity (there is a strong case to be made that the country hasn’t reached full employment since the dot-com bust). Economists do their best to estimate how high gross domestic product could potentially fly before inflation will become an issue, but it’s basically sophisticated guess work. Summers admits this, yet insists it’s still worth worrying about crossing this theoretical Rubicon.
But is it? It’s not crazy to think that Biden’s plan is big enough to create more inflation than we’ve been used to in recent years, especially because the economy’s ability to absorb new spending is still limited by the coronavirus. Last year, prices rose somewhat briskly for things like food, cars, and furniture, because Americans suddenly stopped spending on restaurants and airfare and started spending on groceries and home upgrades, and companies had trouble adjusting production to satisfy all the demand. But Summers isn’t really concerned about a one-time spike on the price of your avocado or new Ford. Rather, he seems to be imagining something much worse and sustained—perhaps a return to the bad old days of the ’70s. “While there are enormous uncertainties, there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability,” he writes.
This is a little bit weird, for a couple of reasons. First, we aren’t living in the Carter era anymore. From the decline of labor unions to our rising resilience to oil prices, the economy is structurally very different in ways that probably make it less prone to hard-to-contain inflationary spirals. More importantly, if inflation does for some reason threaten to flare totally out of control, the Federal Reserve can probably be trusted to snuff it out by raising interest rates.
Well, most people would probably trust it. Summers, for his part, is skeptical that the Fed will be sufficiently cautious about inflation. In fact, that’s pretty much the core of his whole argument. He says inflationary pressures “will be manageable if monetary and fiscal policy can be rapidly adjusted to address the problem.“ But then hints that, well, maybe the Fed will drop the ball.
Given the commitments the Fed has made, administration officials’ dismissal of even the possibility of inflation, and the difficulties in mobilizing congressional support for tax increases or spending cuts, there is the risk of inflation expectations rising sharply. Stimulus measures of the magnitude contemplated are steps into the unknown.
Summers doesn’t really describe the Fed’s “commitments,“ which I think is telling. If he actually did, it would undermine his case. The central bank, which has spent months cheering Congress to spend more, has officially said that it will leave interest rates at zero until America has returned to full employment “and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.“ Vice Chair Richard Clarida has specified that the Fed wants inflation to hit 2 percent for a year before it lifts off. And Chair Jerome Powell has said the central bank isn’t going to hike rates just because inflation flickers a little bit when the economy fully reopens, since it might just be temporary. “Expect us to wait and see and not react if we see small and what we would view as very likely to be transient effects on inflation,“ he told reporters late last month. “Of course, if we did get sustained inflation at a level that was uncomfortable, we have tools for that. It’s far harder to deal with too low inflation. We know what to do with higher inflation, which is that, you know, should the need arise, we would have those tools.”
Our central bankers are basically saying they’re going to let the job market return at least to where it was before the whole world went to hell, even if it means tolerating some transient price increases as people go back to shopping, and then let inflation rise modestly to make up for some lost ground. If anything, they’re probably being a bit conservative about the amount of inflation they’re willing to tolerate. Charles Evans, president of the Federal Reserve Bank of Chicago, has argued that the Fed should aim to drive inflation all the way up to the vertiginous heights of 2.5 percent. (Quick, get me oxygen, I can’t breathe.) He’s considered a relative radical, by Fed standards.
Part of Summers’ point seems to be that, regardless of what the Fed has actually said, its relatively relaxed approach to inflation will convince businesses and investors that they aren’t serious about stopping inflation if it arises. As a result, they might expect prices to rise faster, which could become a self-fulfilling prophecy. But there’s no real evidence that’s the case either. The five-year break-even inflation rate, a key indicator of where markets think prices are headed, just recently rose to about 2.25 percent—which suggests investors are basically listening to the Fed and they believe it.
In short, Summers’ concerns about the Fed and inflation feel … overheated.
They’re especially odd coming from a guy who spent the past decade popularizing the idea that the United States was trapped in a state of “secular stagnation,” in which persistently low interest rates might need to be combated with government spending. Now that Washington’s purse is open, he’s suddenly freaking out. But my guess is that there’s a sort of meta-aspect of personal pride at work here. Many Democrats are now citing the Obama administration’s failure to pass a larger stimulus plan in 2009, and the slow recovery that ensued, as a motivation for going big now. Summers was a key architect of that bill, and while he admits that it should have been larger, I imagine he hasn’t enjoyed the indirect round of criticism. (And to be fair, the Obama White House was operating in a vastly different political climate, one where he was far more constrained by fiscally conservative Democrats, than the one today.) What’s more, Summers was famously passed over for Fed chair during Obama’s second term in favor of current Treasury Secretary Janet Yellen. The man is a natural gadfly; maybe he simply feels the need to say something as he watches rivals explicitly attempt to improve upon his past work.