C. Peter McColough Series on International Economics With Lawrence H. Summers

Wednesday, April 6, 2022
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Charles W. Eliot University Professor and President Emeritus, Harvard Kennedy School; Former U.S. Secretary of the Treasury; CFR Member


Senior Executive Editor and Head of Bloomberg Economics, Bloomberg

Lawrence H. Summers discusses the U.S. economy and inflation, recovery from the COVID-19 pandemic, and the global economic consequences of Russia's invasion of Ukraine.

The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

FLANDERS: (Off mic)—this conversation with my friend and former boss, Larry Summers, U.S. Treasury secretary in the second Clinton administration and director of the National Economic Council under President Obama, now professor of economics at Harvard and, of course, a frequent and recently prescient participant in vigorous public debate about economics and much else.

I’m going to respect the fact that this is part of a C. Peter McColough Series on International Economics and focus most of my questions for Larry on the international perspective. But, of course, given recent developments, given the way, Larry, that you’ve contributed to the debate about the Fed’s policy in the last year and its mistake, as you’ve diagnosed, in failing to see the seriousness of inflation, I feel like we should start with a few questions on the U.S. outlook.

Without going back over the past history, given that the Federal Reserve has by all—made a late start on trying to bring down inflation, do you now think that a hard landing in the U.S. is inevitable?

SUMMERS: I think it’s the most likely thing. If you look at history, there has never been a moment when inflation was above 4 (percent) and unemployment was below 5 (percent) when we did not have a recession within the next two years. So it’s way odds off.

The so-called soft landing examples like 1990—like 1994 are really kind of irrelevant to the current moment. Initial unemployment wasn’t nearly so low. The Fed was adopting a doctrine of preemption that it rejected this time around. The configuration of inflation and interest rates was completely different. So history is very far from encouraging.

Right now, we’re also getting very bad luck in terms of supply shocks and right now the yield curve is at—on an optimistic reading flashing yellow. So I think the odds of a hard landing within the next two years are, certainly, better than half and quite possibly two-thirds or more.

I don’t think the idea that is still embodied in Fed forecasts that we could have continuing super tight labor markets at 3.5 percent unemployment and we could have inflation come down rapidly is a terribly plausible one.

That’s a residue of team transitory, and the key fact one has to recognize, I think, to grasp the current situation is that wage inflation is now running above 6 percent on the best data, which is the Atlanta Fed indicator, and if wage inflation is running at 6 percent, that’s a kind of ultimate core inflation pointing to price inflation at 4.5 (percent) or 5 (percent).

So I think we’re either going to live with that for quite a while, in which case we’ll have an even bigger recession later, or some set of events involving monetary policy and involving what happens in the real economy are going to force a hard landing.

I’m much more agnostic on how high interest rates are going to have to go to generate a hard landing and disinflation than I am on the likelihood that, at the end of the day, we’re going to see a fairly hard landing.

FLANDERS: Just to dig in a little bit in terms of what you think the mechanism is going to be that will bring the U.S. into a recession, I mean, we know and, in fact, it was part of your argument that the stimulus was so large a year ago in the U.S. it left household excess savings quite high, certainly, by historical standards, even in the lower half of the income distribution. Debt service from households is now at a forty-year low. They are coming into this with quite a strong position, even with the inflation that we’re seeing.

So what is the mechanism that’s going to bring the U.S. into a recession?

SUMMERS: I think the two classes of mechanisms that are operative and which one’s going to get there first and their relative timing is something where I don’t have a confident judgment.

One class of mechanisms is monetary policy. I think monetary policy is going to have to keep going until we see disinflation and we’re not going to see disinflation back towards the target range until we see unemployment rise meaningfully. That’s one source of uncertainty, monetary policy doing what it has to do.

The other is the countervailing mechanisms to what you described, the fact that inflation has eroded real incomes and the value of savings, the fact that there’s significant fragility in financial markets, the fact that mortgage rates have risen by two hundred basis points in the last four months and we’re seeing for the first time in many years that lots of people are starting the mortgage process and not finishing the mortgage process. We’re seeing evidence in certain sectors of significantly reduced traffic.

So I think it’s hard to know when and to what extent the economy is going to turn over itself and to what extent it is going to be induced by monetary policy. But I think the judgment that’s hard to escape is that inflation is not going to get near reasonable levels if the economy doesn’t at least substantially slow.

FLANDERS: And you talk about, potentially, the need or necessity of unemployment to go up. I mean, a lot of people—some of your critics would say we’ve got to an amazing point in the U.S. economy, which has—in which U.S. workers have been on the back foot for so long, that you have the unemployment rate at this previously unheard of 3.6 percent.

We’ve got reporters in Indiana where there’s less than 1 percent unemployment and workers in those places have a position of power that they haven’t had in many years. What is wrong with having produced that situation?

SUMMERS: Look, Stephanie, it’s a hugely important question. The first academic work I did was on how important high-pressure labor markets were for the disadvantaged. I showed what was novel at that moment, that a 1 percent increase in the employment ratio for White men was associated with a 6 percent increase in the employment ratio for African-American teenagers.

So I yield to no one in my belief in the importance of helping the disadvantaged and in recognizing that tight labor markets do benefit those who are traditionally left behind. But there are three problems.

The first is that, overall, this higher inflation has gone with falling, not increasing, real wages. You know, if you look at a graph of the nominal wage growth in the United States on one axis and real wage growth—growth in purchasing power—on the other axis, it looks like a turned over parabola.

Living standards grow most rapidly when wages are rising at 4 percent and then they fall off as you start to see wage growth at 5 (percent), 6 (percent), 7 (percent), 8 percent. So the first thing to say is that what we’re doing is we’re having lower real wage growth for the vast majority of the populations as a consequence of this.

The second is the core lesson we have learned is that there’s not a stable tradeoff between unemployment and inflation. There’s a stable tradeoff between unemployment and the acceleration of inflation, and if we run an overheated economy it’s not that we’ll have to live with 4 percent inflation forever. It’s that we’ll live with steadily rising inflation and set up an ever greater price that we have to pay.

Prudent policymakers don’t just pay attention to the current moment. They pay attention to what happens over the longer term, and the consequence of overheating is that it has to be followed by something that, ultimately, stabilizes things, and the history is that if you look at the overall path the poor are worse off once you go through that whole process than they would have been if you kept things stable all along.

That’s why the Fed’s new woke rhetoric in 2021 was so dangerously misguided, and I fear that down the road the people who they were most concerned to help with that rhetoric are going to be the victims if, as I expect, we have some kind of hard landing.

FLANDERS: Given that you started by saying you think that’s the most likely scenario and that you want the Fed to be looking down the track, I guess the inevitable question is how do you think they should be responding to a recession.

Because there’s at least—you know, there’s some argument about the 1970s that actually the Fed sort of easing off on policy in the mid-’70s is what helped set the stage for more entrenched double-digit inflation later on.

SUMMERS: I think the Fed has to stay focused on bringing down the inflation rate and bringing down the expected inflation rate. I don’t think there is any alternative that doesn’t set a stage for greater pain. We can have an argument about 2 percent versus some number a bit greater than 2 (percent).

But I think we need to recognize the—think about this, frankly, in the old-fashioned way, which is less in terms of numerical targets and that is price stability is when people aren’t talking all the time and focused on the overall changes in the price level.

By that definition, we had about forty years of price stability between the mid—thirty-five years of price stability between the mid-’80s and 2021, and by that definition we have lost price stability in the United States. Inflation is now the number-one economic issue. It’s driving vast erosion in confidence in government and the Fed has to do what’s necessary to restore a sense of price stability.

I can’t say exactly what that means in numerical terms but I know that we are well away from it now, in the judgment of the American people. And so I think that’s what’s going to be necessary in terms of monetary policy. I welcome the—particularly, the most recent speech of Chairman Powell, which, I think, moved a long way towards being in the right place.

I still think there is an analytic misconception in what the Fed is projecting. If you’ll indulge me in one—sixty seconds of slightly more technical talk, the neutral rate is a concept that’s about the real rate of interest, the interest rate minus the inflation rate.

The Fed’s view has been that that number is half a percent, and the Fed’s view has been that there’s going to be 2 percent inflation and so the Fed’s view is that the neutral rate is 2.5 percent. The Fed says, look, aren’t we great—we’re going to raise the interest rate above the neutral rate to 2.8 percent and, therefore, we’re above the neutral rate. But that is classic assume a can opener economics because it’s only above the neutral rate if you assume success in bringing inflation down to 2 percent.

So I’d like to see the Fed signal a commitment to raise interest rates until real rates are clearly positive or until it’s clear that price stability has been restored, and I think they’ve moved a long way in that direction. That’s good, if late, but I think they’ve got some distance to go before they achieve it.

FLANDERS: Just one more on this and then we should move on to the rest of the world. But, you know, as you—as you hinted, I mean, it has become an extraordinarily salient issue politically, inflation, maybe more so than you might have predicted given the wages rising more than in step. We listened—

SUMMERS: No. Excuse me. Excuse me. Wages have risen less than in step. Prices have risen 2 (percent) or 2.5 percent faster than—

FLANDERS: Sorry. In some parts of the labor market you have wages—the prevailing rate of wage growth is faster than inflation. But, obviously, you’re right on that overall.

I just wondered if you have—I mean, President Biden, in his State of the Union, he said this is going to be his number-one goal or one of his primary objectives in the next year and beyond, bringing down inflation, and I think some of us were left sort of scratching our heads thinking, well, hang on, what can the administration do since it’s the Fed’s job to be reducing inflation. What can the administration do to reduce inflation?

SUMMERS: Look, the net effect of the things the administration talks about in terms of micro policies to reduce inflation, this gouging talk is frivolous, nonserious, and utterly ineffectual. A gas price holiday would, ultimately, push up prices by raising demand.

The student loan relief yesterday is injecting resources into the economy at a hundred billion dollar a year annual rate when the economy needs to be cooled off, not heated up.

The administration could be much more constructive than it has been with respect to energy supply. So I don’t—the administration’s buy America policies operate in the direction of raising prices as do various policies they pursue to raise small business. So the micro economic policies of the administration are—have been a wash with respect to inflation, at best.

What could they do? The Peterson Institute just released a study that I helped instigate and discussed—it’s on their website—that estimates that a realistic program of trade liberalization could take 1.3 percent off the CPI. There’s scope for policies to increase immigration that would take substantial pressures off the labor market.

But the approaches that would work are approaches that would emphasize increasing the level of competition for American producers, not seeking to protect American producers. That’s the element of microeconomic policy that has a prospect for success.

But I don’t want to misstate the situation. I think, ultimately, inflation is primarily not about relative prices. It’s about aggregate demand and the total level of demand in the economy relative to supply, and we need—we’re going to need to find ways of restraining demand.

I am fearful that the administration’s budget, once you put in a realistic interest rate forecast, not the one that they locked in four months ago—once you recognize the understatement of inflation, once you recognize that we’re surely going to need to increase our national security expenditures, I think it’s going to be very important also to pay attention to fiscal policy in this environment.

But fiscal policy and competitive policies emphasizing the global economy are the tools at the administration’s disposal, and I fear that the more popular themes around corporate gouging and the like are simply diversionary.

FLANDERS: OK. Let’s get on to Ukraine, Russia, and the fallout from the crisis. I’ve been thinking of you the last few years because—the last few weeks because you were a senior Treasury official throughout those two Clinton administration’s in the ’90s, which were really kind of trying to think through how Russia in the end of—after the end of the Cold War how Russia was going to fit into the international economic system, decisions around whether it should join the G-7, all of those things.

Should we be doing more to hurt Russia economically now? What’s your take on the kind of coordinated sanctions that have been achieved and the other actions that have been taken?

SUMMERS: I think by the standards of history and tradition we’ve done a great deal. By the standards of the magnitude of the problem there’s a lot more to do. Understand this. The ruble is now trading at the same exchange rate that it was before the war started. Russian banks are not experiencing runs.

Every day, Russia is getting revenues from the export of its energy products that are comparable to or greater than they were receiving before the war because of increased energy prices. The limitation on the sale of goods to Russia has not been nearly as comprehensive as was imposed on Iran at earlier moments.

The truth is that, in a sense—and I strongly support this—using economic tools is trying to fight a war without costs in blood. That is the right thing. But in important respects, we’ve been trying to fight an economic war without costs to households.

From the first moment when the sanctions were introduced and as it was explained that simultaneously we were going to be doing everything we could to keep gas prices under control, I have felt that there was a moral failure, and if this is a unique and extraordinary worst threat in seventy-five years of naked aggression, then we need to be prepared to make sacrifices at the level of accepting higher energy prices, wearing sweaters on days with cool weather, being a little hotter when we can’t run air conditioners as strongly as we did before, sacrificing luxury exports to Russia and sacrificing mercantile commercial interests. I do not believe that enough has been done. I believe that much more needs to be done.

I was glad to see the step that was taken yesterday to stop the Russians from using their frozen reserves to pay debt. But, in a way, it was an extraordinary and remarkable thing that for the six previous weeks they had been allowed to use their frozen reserves to prevent them from doing it.

So I think that we have a long way to go in raising the pressure that we impose on sanctions and, frankly, I would prefer less rhetoric about the war criminality of what’s going on, which, it seems to me, does not bring pressure to produce peace. If anything, slightly the opposite, by meaning that there’s no exit strategy from this. Less emphasis on that rhetoric and much more emphasis on the imposition of economic pain.

We saw in the United States in 2008 what cascading lack of confidence in finance can do to destroy the performance of an economy. It’s extraordinarily counterintuitive for any financial person.

But I think we need to engage exactly those forces as forces of destruction with respect to the Russian economy right now, recognizing that that may have some collateral implications for some few financial institutions in the West and being prepared to provide the necessary kind of support. But I don’t think we have yet stepped up fully in terms of engaging the tools of financial warfare.

But let me just say a final thing, Stephanie, in fairness. That’s how I see it. That’s how I see it from the outside. But what I have is an outsider’s view, and I’ve been an insider and I have seen outsiders with naive views making it sound simpler than it is. And in fairness to those who are making the decisions, it may be that there are a whole set of collateral costs that they have thought through very carefully.

But my instinct is that there’s a good deal more that could be done and I’d like to see some long queues outside some Russian financial institutions. I’d like to see some Russian defaults, followed by the seizures of key Russian assets, and I’d like to see the ruble in freefall as part of judging the efficacy of a sanctions program.

FLANDERS: When you and I were—actually were at Treasury, the Russian debt default in ’98, I guess, arguably, in retrospect, did more damage to the rest of the world than it did for Russia. Russia bounced back quite quickly but we had quite a lot of financial market turmoil.

How do you see that this time around?

SUMMERS: So I’d say a few things about that. It’s a very good question that I’ve thought about.

First of all, if you look at the real economic statistics and you didn’t have the dates on the X axis, you couldn’t find anything in 1997 or 1998. So it was really exciting if you were talking to people who were involved with the consortium that was bailing out LTCM. But if you looked at the real economy, there was nothing.

FLANDERS: U.S. real economy.

SUMMERS: Nothing just—

FLANDERS: I think other parts of the world wouldn’t necessarily say that. The U.S.—

SUMMERS: No. Even then if you looked at the—well, no, the Russia stuff actually happened at the tail end of the Asian financial crisis. The drama had already, largely, played out in Thailand, in Indonesia, in Korea. So the Russian stage of it was actually at the—was actually at the tail end and I don’t think it had important contagion from any economic point of view. That’s the first point I’d make.

The second is if you look at the magnitude of the debts, they were of a very different level and there’s a, you know, what economists would call a co-linearity problem. Russia and LTCM happened at about the same time. LTCM did not lose its money in the Russian default. It lost its money doing a whole set of other excessively levered things.

So I don’t—I think the right reading of 1998 would, on net, be reassuring with respect to financial warfare towards Russia, not alarming with respect to financial warfare towards Russia.

FLANDERS: And just, finally, on this, I mean, a lot of people—given what seemed to be the initially very effective implementation of sanctions or at least, you know, the surprise that a significant chunk of the Central Bank of Russia’s reserves were going to be frozen, in theory, and various other things, there was a feeling that this was going to be—send a message to the world that the dollar was a bad currency to be in, that U.S. hegemony was something that one needed to find a way around and avoid in the future, at least if you were planning on doing anything that the U.S. might disapprove of.

Given what you’ve said about the ineffectiveness or the relative ineffectiveness of sanctions, I wonder what you think of that.

SUMMERS: I don’t—I never believed that this was going to do enormous damage to the dollar, and the dollar has been very strong since this happened. I never believed it because the dollar—you have to go from the dollar to somewhere.

Is it likely that your euro reserves or your yen reserves will be much safer than your dollar reserves in some kind of major international sanction? No, because there’s—if there is a major international sanction there’s likely to be a global alliance involving the United States, Europe, and Japan.

Is it likely that your RMB assets will be safer? Possibly, but in a more dog-eat-dog world, a more adversarial world, a world where traditional legal norms are less respected, is that really a world where people are going to want to be moving heavily into a Chinese currency? I rather doubt it.

And the last alternative people talk about is crypto. But crypto is its own ecology, and it may become a very important ecology but it’s going to be a long time before you can walk into Walmart with a bitcoin. And so, ultimately, that ecology has to connect back to the dollar.

So I actually do not think that it is likely that this is going to be threatening to the dollar, and I think to the extent that it becomes a much more dangerous world, a world that is more like the pre-Cold War—the Cold War world than the world we’ve known for the last thirty years, I think that’s a world where, ultimately, the relative strength of the U.S. is going to be more important than it has been before.

So with fairly high confidence I would say that this is not, ultimately, going to be a major threat to the role of the dollar, and I would make the broader statement, which, that, you know, we could—nothing is forever. The dollar could cease to be the world’s reserve currency.

But if it does, it will be the least of our problems. It will be because we’ve lost control on inflation. We’ve lost our leadership role in the world. Our democracy has been discredited. And, indeed—and I don’t see this point made often enough. If you think about it, the British pound lost its central role in the international financial system. But if you ask yourself was that a cause of Britain’s decline or was that a symptom of Britain’s decline, I think you would decide that it was much more a symptom of Britain’s decline.

So I think the most important thing we can do for the dollar is to run our country right and strongly and seriously in both the domestic dimensions and the international dimensions of policy.

FLANDERS: To your point, I think the U.S. overtook the U.K. in terms of the size of its economy around the 1870s, 1880s, and it took another fifty, sixty years for the dollar to really overtake.

SUMMERS: Well, I think there’s—I mean, there’s separate point, which is that the dollar has the kind of advantage that the English language has. There are big network effects, which create a lot of inertia.

But then if you ask yourself in the sixty years that—over the sixty years when the dollar overtook the pound, is that why Britain got weak?

FLANDERS: (Laughs.)

SUMMERS: Or did Britain lose the role of the pound because it had exhausted and indebted itself in world wars and lacked dynamism in production and so forth? I think—I think almost any historian would take the second interpretation.

FLANDERS: We’re going to—we must get on to some questions. But I had one more question because I just was sort of thinking about, you know, one of the other things that happened under your watch at the Treasury when we were working together in the late 1990s was the beginnings of the G-20, which was pretty evident in the global financial crisis and the global response to that but has been pretty absent in recent years and, certainly, in response to this crisis or, indeed, the inflation crisis that’s now—and cost of living crunch that’s coming for so many countries.

I wonder, do you think it’s the end of the G-20 or should they actually be now seizing the moment? I think Kevin Warsh has suggested that there should be a joint statement G-20 and the G-7 on global inflation and the determination to tackle it.

SUMMERS: Look, I think the G-20 had a premise. The premise of the G-20 was that all countries wanted all other countries to do better, that we all gained from a more open, more rapidly growing economy, that the United States wanted China to grow faster, that China wanted the U.S. to grow faster, that we all wanted to solve global problems together, and that was the premise of the G-20. And that was, basically, true in the 2008 financial crisis. Everybody wanted the crisis to be successfully weathered and the global economy to grow again.

That is in very profound question today. Self-evidently, it is not the objective of the other—most of the other members of the G-20 to support Russia’s economic flourishing. It is a substantial question whether we are hoping for the success of the Chinese economy and whether China is hoping for the success of our economy.

So the premise of the G-20, which was a forum for devising means to shared ends, is much less evidently true today, and before one talks about what you should convene a G-20 meeting to do and what kind of statement a G-20 should make, it seems to me one has to get straight these questions about which communities have which shared ends.

Right now, I perceive a bit of a vacuum in clear thinking on this with some traditionalists wanting to just kind of keep going with the G-20 and have G-20 do stuff, and others have what seem to me to be rather naive, given the world we live in, conceptions of communities of democracy, which, it seems to me, do so much to exclude so many major stakeholders in the economic system that there’s a real question as to whether they can be meaningfully effective.

So I think we need some serious reflection on the mechanisms of international fora and consultation. I don’t know that we’re in the right place right now. But I think it takes a kind of realism that balances sort of two clichés—one, some sharing of ends is a prerequisite to successful cooperation and the other is you don’t make peace with your friends; you make peace with your potential adversaries.

And so I suspect we need to use the European term “some kind of variable architecture” in which there are some fora where there’s more in common among the participants but less reach and other fora in which there is less in common among the participants but more reach.

Anyone who thinks that these descriptions and that these kinds of issues—and this is a place where I’ve gone from naive and stupid to less naive and stupid. I used to think that serious people discuss serious things and diplomats discuss the shape of tables and I think I’ve now come to realize how important the shape and composition of groups can be and anyone who doubted that proposition needs to consider how consequential the rather loose statements that were made about allowing Ukraine into NATO proved to be in terms of what they set off.

FLANDERS: I’m sure what you’ve just said would be very resonant with a lot of the members of the Council on Foreign Relations watching, and it reminds me a little bit of what you said earlier about the dollar, that, in a sense, it’s sort of—it’s not just the role of the G-20 that’s important. It’s the reasons for the questioning of the G-20 that are important, and it’s pretty profound the change that you’re talking about.

OK. So we must go to questions now, and I know that Carrie is going to lead us into going to the first questioner.

OPERATOR: (Gives queuing instructions.)

We’ll take our first question from Grace Gu.

Q: Hey, Larry. Thank you for the very enlightening conversation as usual. This is Grace Gu from Two Sigma.

So I have a question—two questions along the direction of Fed policy. The first one is on your comment of, you know, inflation has to be anchored. I very much agree with that, but I’m curious what’s your thought of the pandemic’s, you know, implications to inflation.

So the Fed has underestimated the disruptions on supply chain. But at this current moment, we are likely looking at peak inflation in March and a subsequent V-shaped decline. To what level we don’t know, but this is the likely trajectory, you know, due to the pandemic disruptions. So I’m curious to your thinking of, you know, does the Fed need to be so aggressive, given that we know inflation is trending lower?

And the second question is related to Fed policy but, you know, your mentioning of economic war, and I thought that was a very good assessment. So part of the costs to pay for economic war or for a war is living with somewhat higher cost of living, and in the past when we were going through World War I and II and other types of wars, my understanding is that policy has been somewhat more attuned towards other objectives. So I’m curious to hear your thought on, you know, whether the Fed should take this into account. Thank you.

SUMMERS: I don’t think the kind of fiscal dominance that is associated with major mobilizations of 15 (percent), 20 (percent), 25 percent of GDP to fight wars—I don’t think that connects with the current moment.

I think we’ll see how transitory and what the effects of pandemic developments are. I, in general, think—and Jason Furman has developed this point at some length—that pandemic aspects have supply effects and they have demand effects. They affect how many people go to the bar and how willing people are to be bartenders.

And so I think their effects on inflation are rather more ambiguous than is generally supposed, and I am a bit less bought into the view that inflation is going to decelerate rapidly of its own account than, I think, the Fed staff are or that, I think, some in the markets are. But we’ll see what happens.

FLANDERS: Carrie, the next question.

OPERATOR: We’ll take our next question from Graham Allison.

Q: Thank you, Larry, for a terrific discussion—and Stephanie—for such pointed questions.

So in your initial answer and your high confidence about inflation and where it’s going, you started with history and reasoning from history, but you’re also reasoning from economic theory.

So as somebody who carries a banner for applied history, I would—say a word about how in making such a confident judgment the combination of the historical experiences that you’ve thought about in a granular—at a granular level and theory are combined.

SUMMERS: Look, what led me to the judgment that I made a year ago that whatever happens in the future, I think, one has to say was correct that the Rescue Act and the posture of the Fed was cumulatively going to produce much more inflation in a much more problematic way than people thought—what led me to that judgment was knowing a fair amount about the history of the guns and butter period during the Vietnam War and the associated escalation of inflation and the way in which it was a universal surprise to progressive economists, and that was what led me to the judgment.

So I was, in a sense, using the kind of method you have advocated, that the only thing we have to learn from empirically is history. So think about historical parallels and then think about ways in which the current situation is different or the same and ways in which those increase or decrease the pressures.

And if you’re saying that something’s going to happen that has happened many times before, then you should be more confident that it’s going to happen. If you’re saying that you have a theory that something’s going to happen but you don’t have any examples where it did happen, then that should give you much less confidence in the theory.

So the strongest historical judgment I would make today is that the analogy between past soft landings and the current situation is, I think, extraordinarily weak. So I think the right reading is that there are no examples of soft landings from situations like the present.

That doesn’t mean we can’t have one. But it should, certainly, affect how one bets. In general, I think there’s a tendency to neglect background probabilities. The reason why I’m more sympathetic to the new generation of political scientists who do quantitative research is not because I don’t recognize that every conflict has its own nuance.

But if there’s some generalization, you know, 80 percent of conflicts end with the ruler of a losing country staying in power, if there’s some generalization like that, that background fact should inform your judgment in any particular instance. And so that would be how I would think about the use of applied history.

FLANDERS: I would say that was a characteristically Council on Foreign Relations exchange that you’ve—we’ve paid for one Harvard professor but we got another one for free.

Next question.

OPERATOR: We’ll take our next question from Dhruv Singh.

Q: Thank you very much. Thank you, Professor Summers. This is Dhruv Singh from affiliate with DEWS Holdings.

My question, Professor Summers, was, you know, and thank you, prior professor, for the question because mine was building on it, which was, you know, about what are the most harmful fundamental flaws in team transitory’s logical case to take a less aggressive response to the economy overheating today, which, I think, you touched on in your prior question.

Building on that, given your understanding—and this is an and—given your understanding of how insiders’ views evolve and the politics that’s necessary in changing a position once it’s proven wrong, what’s your best guess on what needs to happen from here for there to be a market evolution on the aggressiveness with which today’s clearly overheating economy is addressed and handled?

SUMMERS: So, look, I think the biggest mistakes that team transitory makes are three. One is they say they’ve given up the position, but if you look at the Fed’s forecasts they really haven’t, and they’ve given up the labeling because they were getting killed on the labeling but they haven’t really given up the conviction. How else could you forecast that inflation would revert to normal with unemployment staying at 3.5 percent?

So there’s disingenuousness in the rhetoric. They’ve given up the marketing strategy, not the policy.

Second, team transitory always, and this is—there’s a team—if you look at every inflation it has its team transitory that points to special factors and they’re always the same two mistakes. One is they only look at special factors that go in their direction, not special factors that go in the other.

So, for example, anyone who’s tried to buy a house or rent an apartment knows what’s happened in the American housing market. CPI inflation for housing, which represents 40 percent of the core CPI, as of this moment is 4 percent over the last year. So there’s a lot of catch up and acceleration that’s yet to come.

Talk to anyone who’s near a hospital and nurses are quitting in droves, and nobody’s forecasting the associated increase in health inflation. So the first problem is they only focus on the things that make their point, not the things that are going in the opposite direction.

The second classic problem with teams transitory is that they forget the macroeconomic insight that inflation is about the overall price level, not relative prices. If used cars go up and people are paying more for used cars, they have less money to spend on other things and that exerts restraint on the inflation of those things.

If used car prices come back down and people have more money to spend on other things and that operates to push those things up. So when you point to high relative prices in particular sectors as evidence for the team transitory view, you neglect that those relative prices are just that, relative prices, and the other side of the market is having impact.

I mean, so far, team transitory—everything team transitory pointed to eight months ago over the summer—the median inflation, the trend in mean inflation, the median, all these various indicators—all of them have gone from the green that team transitory was predicting at that time to flashing red.

Now, that doesn’t mean they’re going to be wrong, going forward, and I’m sure we will not sustain—not sure, I expect we will not sustain an 8 percent CPI. But there’s a long way for measured inflation to come down before it gets to acceptable level and believing that all of that is going to happen just because of the reversal of unfavorable shocks is not inconceivable at all.

But it doesn’t strike me as being anything like the kind of middle scenario that one should use in forecasting, let alone the kind of “hope for the best, plan for the worst” scenario that prudent policymakers use.

FLANDERS: Just the beginning of that question made me wonder. I mean, the Fed had one job. It has monumentally failed on that job on a consistent way for the last year and, potentially, into the future with this strategy. If a fund manager made that kind of bad call for such a long time there would be pretty concrete consequences. If an elected politician made that kind of mistake there would almost certainly be consequences.

Do you think there should be greater accountability for this particular failure for the forecasting system that produced it but even, potentially, individuals?

SUMMERS: I think the Fed should be much more visibly acknowledging that it’s been wrong and seeking to understand and learn from its errors than have been the case, and I think the failure for there to be some institutional review. You know, after bad battles armies have after action reviews.

The IMF has blundered in various situations and there have been very thoughtful reviews of what in its culture and what in its mode led to those errors, and I think the Fed should be engaged in more of that. I think, in fairness to the Fed, the views they were expressing were relatively close to consensus views, not, frankly, this last fall when, I think, they were behind the consensus and still sticking with their views.

But for much of last year their views were tracking consensus views, and so I think the soul searching is less about accountable individuals at the Fed than about how those consensus views were formed, and I guess I have been struck by a certain blitheness with which some of my friends in the economics community have kind of pivoted to addressing the current moment without thinking about what led them to be wrong in the past.

FLANDERS: Well, I think we’ve had some pretty feisty commentary about the Fed and other things today so I should catch you in sort of conciliatory mode to bring this to a close. We’ve run out of time.

But, Larry Summers, thanks very much for an excellent exchange on issues that I know will be of great interest to all the people listening in. Carrie?

SUMMERS: Thank you, Stephanie.


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