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Bull Trader USA

: Summers says Fed will struggle to engineer soft landing as he frets about ‘spontaneous deflating’ in markets

Former Treasury Secretary Larry Summers was right that inflation would prove longer lasting than Federal Reserve and White House officials believed at the beginning of the year.

Now Summers says the Fed, which is likely on Wednesday to forecast multiple interest rate hikes next year, will have a hard time putting the inflation genie back into the bottle without causing a recession.

In a webinar held by the American Council for Capital Formation, he likened monetary policy to trying to adjust the water temperature of a shower in an old hotel, due to the lag in how the economy responds. That’s why, he said, the Fed has frequently caused recessions when it reacts to stamp out inflation.

“There have been moments when the Fed acted mildly and preemptively, 1995 for example, to create what we might call a pause that refreshes with respect to an expansion, but that was when it was activng with a doctrine of looking ahead, not the current doctrine of no action until inflation is absolutely established.”

“I think the difficulty of engineering a soft landing in which inflation comes down but we don’t see a real problem is, I think, very challenging,” he said.

Another risk: Summers warns of a spontaneous deflating of financial assets, ticking off crypto, meme stocks, technology stocks, and SPACs. “Super-excited retail is usually a sign of trouble to come,” he said.

Already, the Nasdaq Composite
COMP,
-0.56%

has retreated 5% from its record high.

Summers said he was glad to see that Fed Chair Jerome Powell and Treasury Secretary Janet Yellen are retiring the word “transitory” from their vocabulary. He said the Fed should immediately stop purchasing mortgage-backed bonds, and phase out government bond purchases by the end of the first quarter, which will allow for multiple rate hikes.

“I find the idea that very gradual increases of rates will be sufficient to contain inflation to be somewhat implausible, given what is happening in the labor market,” Summers said.

Summers explained why he was against the size of the $1.9 trillion stimulus plan signed into law by President Joe Biden. He said he foresaw a GDP gap of about 3%, but the stimulus provided aid equivalent to 14% of GDP. Another way to look at it was that labor income was running about $25 billion per month below trend, to which $200 billion per month of aid was provided.

Summers also said the significance of the omicron variant is that it’s a much more dramatic mutation than what was seen previously, which implies another major mutation could also come. Employing a baseball analogy, he said it’s possible that the coronavirus situation is in the fifth inning, rather than the seventh.

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