Making sense of today’s confusing economic signals is difficult. It’s no surprise Larry Summers finds something for both sides of the fight over President Joe Biden’s policies.
The eminent Democratic economist has done it all year. In May, he warned that Biden’s $1.9 trillion American Rescue Plan risked over-stimulating the economy and sparking inflation; Republicans have invoked those warnings ever since.
Yet Summers also says Congress should pass Biden’s $1.9 trillion Build Back Better Plan over GOP opposition because it would boost long-term growth without significantly increasing inflation. Democratic leaders have crossed their fingers that West Virginia Sen. Joe Manchin listens.
Lately, economic data offers cross-cutting superlatives nearly every day. Last week, new unemployment claims fell to a 50-year low – just before data releasd on Friday showed monthly inflation for November registered a 40-year high.
Summers, a former top economic adviser to Presidents Bill Clinton and Barack Obama, sees neither unalloyed prosperity nor dangerous decline. Instead, he acknowledges immense uncertainty that allows for either outcome or something in between.
The inflation spike Summers sounded early alarms about has dominated political debate in recent months. Fueled by a vexing combination of elevated demand and constrained supply, higher prices for gas, food, appliances and shelter have outstripped the wage increases Biden has touted. They’ve also eroded Biden’s approval ratings and darkened Democratic prospects in 2022 congressional elections.
But the economy has also shown important strengths in its recovery from the coronavirus calamity. The Federal Reserve projects 2021 growth at 5.9%, the highest since 1984, as the US became the first advanced industrial economy to return output to pre-pandemic levels. Employers have added 6 million jobs, more than in any other president’s first year.
Unemployment has fallen to 4.2% three years before economists previously expected. Covid relief checks have boosted household income higher than before coronavirus. Even the thorniest immediate problems – supply chain kinks and high oil prices – have begun easing.
Summers acknowledges that the rescue plan he criticized has lifted growth and employment. And though workers’ wages overall have lost ground to inflation, wages of lower-paid workers have run ahead – a small step toward the Democratic goal of curbing income inequality.
But he fears sustained inflation will render those gains fleeting. The tighter monetary policy the Federal Reserve has signaled to cool the economy could have unpredictable and painful effects.
“The economy would be weaker right now” without Biden’s rescue plan, Summers conceded in an interview. “If I drive 90 mph, I will get to New York faster. But I’m at higher risk of crashing.
“We’re going to have to slow the car in a controlled way,” he added. “It may not be so easy.”
Currently, Summers pegs chances at 50% that inflation will settle in at perhaps twice the Fed’s 2% target – for years. If the problem snowballs anything like it did in the 1970s, when expectations of higher prices became self-fulfilling, taming it could force an excruciating downturn.
Summers sees a 30% chance that Fed tightening will trigger another recession, just three years from the last one, within the next 18 months. His least likely scenario – a 20% chance – is that the Federal Reserve pumps the brakes skillfully enough that demand and supply resolve imbalances harmoniously enough to sustain growth.
White House economists, and some on Wall Street, paint a more hopeful picture. It begins with vaccinations taming the pandemic and tempering inflation in multiple ways: by reducing Covid-related production bottlenecks, drawing more workers to the labor force, shifting consumption back toward services and away from goods as normal life returns. As supply expands, the end of Covid relief will moderate demand.
Summers calls that too sanguine. To begin with, the new Omicron variant of the coronavirus underscores the possibility that the pandemic may resist taming indefinitely.
Moreover, Summers notes that the earnings of those returning workers will themselves increase demand. So will spending by Americans who so far have saved big chunks of those relief checks.
“The notion that the end of the pandemic is going to be inherently deflationary is a confusion,” Summers said.
The steps he recommends to reduce inflation risks lack political appeal. One is eliminating the full or partial restoration of federal deductions for state and local income taxes - which House Democrats say has become essential to amassing the votes for Biden’s Build Back Better bill.
Another is adding more tax hikes on corporations - which Senate Democrats fear would also sink the bill by losing the vote of Arizona Sen. Kyrsten Sinema. A third is lifting import tariffs on China – which for foreign policy and domestic political reasons Biden won’t do anytime soon.
Summers allows that economic good fortune could render his warnings overblown. “I don’t want to over-argue my case,” he said.
Maybe Americans have grown so accustomed to low inflation that behavior-altering “inflation expectations” won’t take off. Maybe new remote-work arrangements forced by the pandemic will produce efficiency gains as technological advances did in the 1990s.
Even such a “soft landing” may not save Democrats next year, since voter attitudes rarely improve as fast as the economy itself. What has lifted struggling presidents before are foreign policy crises or other unexpected events that quickly reframe the political agenda.
“The picture,” Summers observed, “is a long way from frozen.”