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Evolving Investor
4 Inflation Talking Points with Larry Summers
Key Takeaways:
- Inflation didn’t catch economic leaders by surprise.
- Calm investor fears by reminding them that recession is a natural consequence of inflation.
- To forecast, keep an eye on the Federal Reserve and the Economic Cost Index.
- A historical perspective is ultimately hopeful.
Today's investors have more access to economic data than any previous generation – and when words like “inflation” and “recession” are trending, they call their advisors. To meet the moment for the Evolving Investor, advisors must guide their clients through inflation anxiety and recession fears.
At MICUS 2023, Morningstar welcomed former U.S. Secretary of the Treasury, Lawrence Summers, to the stage to share his thoughts on the economic future of the United States. Below are a few takeaways that advisors can use in their client conversations.
1. Inflation didn’t catch economic leaders by surprise.
Lawrence Summers was one of the first and most vocal individuals raising concerns about the inflationary risks of the fiscal policies of the past few years, especially the American Rescue Plan in early 2021.
“It was easy [to predict] 2.5 years ago,” Summers said, “We had an economy that was short of its potential by about $30 billion a month, and we injected about $180 billion a month into it. We told everyone that the interest rate would stay zero until 2024, and at the same time, the FED was buying $150 billion of bonds a month, bloating its balance sheet. So it’s pretty obvious that the bathtub was going to overflow, and that manifests itself in higher inflation.”
Summers acknowledged that forecasting inflation going forward is more difficult. There is a lot of noise surrounding inflation – fluctuating gas prices, for example – but given the tight labor market, wages rising in the 5% range, and a lack of productivity growth, Summers thinks hitting the 2% inflation targets is unlikely unless the economy slows down significantly.
It tends to be a bad idea to make very specific forecasts because people are going to remember them three months later and they’re going to be wrong.
When it comes to the 2% inflation target, Summers’ comment was, “It tends to be a bad idea to make very specific forecasts because people are going to remember them three months later and they’re going to be wrong.” He suggested that offering a target range would be better for both credibility and public confidence.
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2. Calm investor fears by reminding them that recession is the natural consequence of inflation.
The pain of inflation is obvious - price increases relative to wages leads to diminished purchasing power. But recession is also a natural – and perhaps necessary – result of inflation.
“[Inflation] is like any kind of high...” Summers said, “The higher the high, the more painful the low.” He pointed to the 1970s as an example. “One of the core errors the country made was that it didn’t like inflation, but it didn’t like curing inflation even more,” he said, “And so that created a dynamic where inflation drifted upwards, and you had an excruciating experience of the Volcker’s recession in the early 1980s.”
Inflation is like any kind of high...the higher the high, the more painful the low.
While recession may be imminent, Summers pointed out that the current facts don’t suggest that the recession will be like the COVID recession, the Great Financial Crisis recession, or even the 1982 recession, when employment reached 10%. His prediction is that the upcoming recession will see employment numbers get to six.
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3. To forecast, keep an eye on the Federal Reserve and the Economic Cost Index.
Summers acknowledged that the Federal Reserve has a difficult job. “It’s like when you’re in an old hotel,” he said, “And the water’s too cold. You turn it and nothing happens. You turn it again and nothing happens. You turn it again, and then all of a sudden it’s getting very, very hot.” Adjusting interest rates are a blunt instrument, and judging how much to adjust is a difficult call.
It’s like when you’re in an old hotel,” he said, “And the water’s too cold. You turn it and nothing happens. You turn it again and nothing happens. You turn it again, and then all of a sudden it’s getting very, very hot.
“My guess it that the right thing for the Fed to do is to raise rates by 25 basis points,” Summers said, “but to signal that...they’re going to be monitoring the data very closely.”
However, Summers also pointed out flaws with the Federal Reserve, suggesting a tendency to “groupthink around particular macroeconomic models...I think in general, institutions do much better when they institutionalize very substantial dissent and consider very substantial divergences from their main scenario.”
In Summers’ opinion, the number to pay attention to is the economic cost index – a quarterly measurement of what’s happening to wage inflation and underlying cost, that is adjusted for the composition of the labor force.
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4. A historical perspective is ultimately hopeful.
Despite the current market difficulties, Summers ended the session on a note of hope. “I have spent the last few years traveling the world,” he said, “And I would rather be playing America’s hand than playing the hand of any other major country...”
“If you look at the collective value of all the American companies relative to all the non-American companies, that is at its highest level ever,” he added, “Used to be that American stocks were at 40% of the value of the stock of the global stock market...now it’s over 60%.”
I think you have to be impressed by the record of the United States...I think that we have this capacity as a country for the resilience that comes from being alarmed, and then doing something about it.
Though he acknowledged that worrying about the dollar is helpful because it pushes the government to “do more responsible things,” he also pointed out that the dollar is very high by historical standards. “I think you have to be impressed by the record of the United States...” he said, “I think that we have this capacity as a country for the resilience that comes from being alarmed, and then doing something about it.”
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