larry summers inflation

Former Treasury Secretary Larry Summers has warned Central Banks against lowering the guard against inflation. His views are in contrast to some of the other economists who believe that the Fed should pause its rate hikes.

Summers said, “The greatest tragedy in this moment would be if central banks were to lurch away from a focus on assuring price stability prematurely and we were to have to fight this battle twice.”

His remarks came after former IMF chief Olivier Blanchard joined the chorus of economists who are calling upon central banks to raise their inflation target from 2% to 3%. Summers ridiculed the idea at the WEF (World Economic Forum) and said, “To suppose that some kind of relenting on an inflation target will be a salvation would be a costly error.”

Notably, the Fed and ECB (European Central Bank) target a 2% inflation. Developing countries have different targets. China for instance was targeting a 3% inflation for 2022. India targets an inflation range between 2-6%.

Here it is worth noting that previously the Fed jumped into action whenever the inflation breached 2%. However, in 2020, it changed its methodology to average inflation targeting. Markets liked the move as it suggested that the US central bank would keep rates lower for longer.

US Inflation Surged to Multi-Decade High in 2022

Even as the US CPI surpassed 2% in 2021, the Fed waited until March 2022 for its first rate hike. It started with a 25-basis point rate hike but eventually moved to 75-basis point rate hikes.

However, in December, the US central bank raised rates by 50 basis points which was in line with expectations. It raised rates by a total of seven times in 2022 after which the Fed fund rate is 4.25-4.50%.

US CPI surged to a multi-decade high of 9.1% in June but fell in the subsequent six months. In December, the CPI rose at an annualized pace of 6.5%. On a monthly basis, both the CPI and wholesale inflation fell 0.1% in December.

High inflation and the resultant rate hikes took a toll on risk assets last year. However, some investment strategies can outperform during high inflation.

Summers Warns Against Lowering the Guard Against Inflation

Summers warned against lowering the guard against inflation even at the risk of a recession. He said that if the central banks get complacent with inflation in order to boost the economy, they would risk an even more severe recession in the future.

Fed’s rate hikes, recession fears, and the fallout of FTX bankruptcy have also taken a toll on digital assets. We have a guide on whether crypto is recession-proof.

Meanwhile, Summers’ views are at odds with many other economists and analysts who believe that the Fed is making the mistake of overtightening.

Wharton professor Jeremy Siegel believes that the Fed has won the war against inflation. He does not see the Fed raising rates after a 25-basis point rate hike at the upcoming meeting. The Fed’s dot plot calls for 75-basis point rate hikes in 2023.

At the press conference following the December FOMC meeting, Fed chair Jerome Powell said, “We continue to anticipate that ongoing increases will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”

Markets Expect a 25-Basis Point Rate Hike in February

The Fed’s first meeting of 2023 would begin on January 31 and conclude on February 1. Traders are now putting an almost 100% probability of a 25-basis point rate hike at the meeting.

Many Fed officials including Governor Christopher Waller have backed calls for a 25-basis point rate hike at the next meeting.

The US economy has slowed down and many companies including tech giants like Alphabet and Microsoft have announced mass layoffs. The Fed faces a tough balancing act amid a rapidly slowing US economy and the still high inflation as it prepares for its first meeting of the year.

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