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Summary:
- Speaking on Bloomberg, Larry Summers warned that recent economic data did not confidently point towards continued slowing in inflation. This raises the risk that the federal reserve will need to raise interest rates more than expected.
- Summers reasoned that job creation and wage inflation pointed towards an “underlying” inflation rate of 3.5%, well above the federal reserve’s 2% target.
- Summers also believes the US is on an unsustainable fiscal path, and that budget deficits may fuel inflation and pose risks to financial stability.
Full Synopsis
Speaking on Bloomberg Wall Street week, Larry summers expressed concerns that the US economy was proving to be stronger than expected and that this may pose risks to the trajectory of inflation. Summers specifically cited jobs numbers and wages as posing a risk, citing that with 187k jobs created each month, job creation was faster that the US population growth rate of 50k – 100k. Summers also emphasized that wage data may be reaccelerating, citing higher month-over-month and quarter over quarter wage gains (5.0% and 4.9%) vs year-over-year wage growth (4.5%).
Accelerating wage data is a concern since Summers views wage increases as the difference between underlying productivity growth and the inflation rate. Given that US productivity growth has generally averaged 1%-1.5% over the past few decades, a 5% growth rate in wages points towards approximately a 3.5% underlying inflation rate.
Inflation of 3.5% would be significantly above the federal reserves stated goal of 2% inflation, and a reacceleration of wages could pose upside risks to this estimate. If inflation reaccelerates to the upside, it could force the fed to the federal funds rate above the current 5.25%-5.5% target range. Increases in federal funds rates above expectations generally pose downside risks to stocks and bonds.
Summers also discussed the concerns about the trajectory of the US budget deficit, calling it an unsustainable path. Noting that the the CBO projects a 7% deficit within 8-10 years, Summers enumerated upside risks including tax receipts trending below expectations, the likelihood that Trump tax cuts will not be phased out, and the likelihood of increased defense spending among others. Summers believes that the current fiscal trajectory may support inflation and reduce the financial resilience: of the United States.
