The Causes and Potential Cures for Inflation

Please excuse typos.

Joe Selvaggi:

This is Hubwonk. I’m Joe Selvaggi.

Joe Selvaggi:

Welcome to Hubwonk, a podcast of Pioneer Institute, a think tank in Boston. Inflation is here. After a 40 year hiatus, the phenomena characterized by rising prices and an attending falling of purchasing power had reached 8.2% at the end of September, 2022, before the demand shock of the Covid 19 pandemic. Many had warned for decades that accommodated monetary policy and mounting federal debt might eventually invite inflation, but is not until in the wake of the pandemic with the passage of the nearly 2 trillion fiscal stimulus bill known as the American Rescue Plan, that broad persistent inflation became an undeniable reality. American consumers discouraged and disoriented by the effects of inflation are eager to understand it’s causes. Did macro economists anticipate the danger of inflation from massive fiscal stimulus only to have their advice ignored, Or after two generations of stable prices were both policymakers and economists alike, complacent about the danger of overstimulating economy rapidly recovering from a pandemic.

Joe Selvaggi:

To answer these questions, Hubwonk has enlisted the help of two prominent Harvard economists to serve as host and guest to discuss the source of the current inflation surge and the reasons many economists either missed the warning signals or failed to effectively dissuade policy makers from making choices that greatly exacerbated the problem. My guest is Professor Larry Summers, an economist who served as the 71st United States Secretary of the Treasury from 1999 to 2001, and is director of National EC Economic Council from 2009 to 2010, and was the president of Harvard University from 2001 to 2006, where he is a professor and director of the Mossavar-Rahmani Center for Businesses and Government at Harvard Kennedy School. Our guest host for the discussion is Professor Edward Glaeser, the Fred and Eleanor Glenn, Professor of Economics at Harvard University, who served as director of the Taubman Center for State and Local Government and director of the Rappaport Institute for Greater Boston. He has published dozens of papers and four books on city’s economic growth, law and economics. It is a pleasure to note that Professor Glaeser is also a member of Pioneer Institute’s Board Directors. The discussion is from an October 19th live webinar hosted by Pioneer for our members and includes answers to audience questions at the end when we return. Hubwonk guest host Professor Ed Glaeser will discuss causes and potential cures for inflation with former Secretary of the Treasury and Harvard University President Economist Professor Larry Summers.

Ed Glaeser:

Now Larry, I want us to start in February, 2021. In fact, we can think about a particular day on February, 2021, February 4th, 2021. And I wanna remind our listeners that as of February, 2021, the 12 months inflation rate had been 1.7% for that, that month. And going back over, gosh, roughly 30 years, with the modest exception of the oil price hikes in 2008, inflation had been incredibly stable and incredibly low, at least relative to the experience that those of us who lived through the 1970s and early 1980s had gotten used to in those decades. On February 4th, 2021, you wrote first. While there are enormous uncertainties, there is a chance that macroeconomic stimulus on a scale closer to World War two levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation with consequences for the value of the dollar and financial stability. You’re of course, writing about the American Rescue Plan, which did pass. It was a 1.9 trillion dollar bill. How is this missed? What do we learn about, you know, how did you get it right? And so many other people get it wrong? And what do we learn about the way that, you know, macro economists think about the world that, that they were able to get this so wrong?

Larry Summers:

It’s a great question, Ed, and I don’t presume to completely know the answer. And by the way, the fact that you quoted me as saying with consequences for the dollar, and in fact the dollar has gone up rather than going down, shows that even while I think I got the big picture right, there were important aspects of this situation that I didn’t see. Let me tell you what my method was. My method was a combination of arithmetic and historical analogy. The arithmetic was looking at how far below trend incomes were running and seeing that they were running about $30 billion a month below trend. And then observing that we were proposing to augment them by 150 to $200 billion a month, and thinking that even if capacity in the economy was robust, which seemed unlikely after the pandemic, that would create very substantial excess demand, which would generate inflation.

Larry Summers:

That was the arithmetic that I did. The historical analogies that I look to were three World War ii, where we spent 25% of GDP on defense. And this was about, and this was about 15% of GDP in stimulus all to be delivered in a year. And that produced substantial excess demand in the World War II case. We used price controls. That was not something we were gonna do. Now, second example I looked to was a formative experience for me at economics. The Vietnam war inflation where LBJs collision between guns and butter combined with a fairly craven fed led inflation to go from 1% in 1966 to having a six handle to the nearest integer by 1969. And this seemed like something much larger than that. And the third example I looked to was the Obama stimulus, where there was a consensus that the stimulus would’ve been better if it had been larger, a consensus I very much shared in at the time, but political constraints did not permit.

Larry Summers:

But the consensus was that perhaps it should have been twice as large and relative to the size of the gap that had to be filled, this stimulus was about five times as large as the Obama stimulus. So it seemed to me that it was fairly clearly overstimulated. And then on top of that, you had the fed with the floor, with the accelerator to the floor between zero interest rates and massive quantitative easing. And you had a big savings overhang that was waiting to be spent from all the people who couldn’t go to restaurants or take vacations in 2000 and in 2020. So it seemed to me obvious that if there was such a thing as overstimulation, we were headed for it. Now, the question that puzzled me at the time was why everybody else didn’t agree. I’ve been doing this for a long time, and I frequently have policy views about which there is not consensus as to the economic outlook.

Larry Summers:

I can’t remember another moment when I thought the consensus outlook was so misguided. And so I don’t really understand why the consensus view wasn’t closer to the view I expressed. I think elements of the explanation include the following. If you do a statistical analysis on a number that is roughly constant for 40 years, you will conclude that nothing can change it very substantially. And so any econometric analysis of the last 40 years kind of, of concluded that inflation was impervious to change, and a lot of people were acting on the basis of those kinds of econometric analysis. Like that’s one very important technical source of error. I think a second technical source, a second source of error was just a broader phenomenon of short memories and wanting to be wrong in new ways. The problem for the previous decade had been what I had labeled secular stagnation, insufficient demand inflation below its target.

Larry Summers:

Everybody who had said there was gonna be a lot of inflation. There was a famous letter written in late 2009 or early 2010 by a whole set of conservative economists and financiers warning that Ben Bernanke had the country on the brink of hyperinflation. All the Warners had been wrong, and that discouraged people from being Warners for 40 years. I think that’s the second thing. I think the third thing was there was deference to people who hated Donald Trump and who Donald Trump hated, and they had decided to embark on this plan. I think one of the less commented on of the Federal Reserve sins, which are many in this period, was the failure to strike any cautionary note at all about the magnitude of the fiscal stimulus that was being provided. During this period, I think the Biden administration was influenced more by macro political factors than macroeconomic factors.

Larry Summers:

There was a very understandable feeling that as Rama Manual put it, a crisis is a terrible thing to waste. And here we had this new moment of opportunity. And so there was a desire to do a whole set of socially important things, and I think there was some wishful thinking with respect to arithmetic. I think, and maybe this is a final point to make many have been sharply critical of those who were in authority. And obviously I had a very different view about inflation than they did. I think it’s important to recognize in assessing the Fed or in assessing secretary yell, or in assessing the Biden administration, that the positions they took were in line with the consensus of economic forecasters. Were in line with the vast majority of Wall Street forecasters. And so this is, I think, more of an intellectual failure of the macroeconomic policy community than it is, than it should be thought of as the politicians discarded the advice of experts, because most of the advice of experts actually was kind of on the inflation, is not a serious problem side.

Larry Summers:

I would say also that some of this relates to the fact that some of the more purely academic analysts of these matters who don’t think of their role in the system as being, spending time in Washington or pivoting on policy, but think of themselves as more pure scientists had largely discredited themselves with a set of rather implausible and esoteric doctrines that led them to be largely tuned out of the policy community and tuned out by the policy community. And that tended to leave the field to the more politically minded within the economics profession. And that’s an additional element to this.

Ed Glaeser:

Thank you, Larry, for that very comprehensive answer. I, I wanna follow up in particular about this being a failure of the macroeconomics profession or, you know, let’s just say the economics community writ large. And one way of thinking about what we do is there are sort of two things that are wrapped up in being an economist, let’s say over the last 70 or 80 years. One is the traditional worldly philosopher, right? The traditional person who drew on exactly the things that you drew on to making your, you know, quite sensible and, and impression prediction. Which is, you know, the, the sort of things that Adam Smith knew. So we know a bit of about history, we’re able to do some, some basic calculations. We have a lot of common sense, right? There’s another tradition which is, you know, the white lab coat scientist. And if I think about someone like your uncle Paul Samuelson, he was someone who was very much like on the cusp of those two things.

Ed Glaeser:

He was both a forerunner of the scientific path that economics would take, but still, you know, he wrote columns and his columns said sensible things about, about economic policy over the last 50 years. There is no question that the science has defeated the worldly philosophy within our profession, that if we look at our young kids the PhD students in our profession, they are being trained to be scientists and they’re not being trained, in fact, to give wise impression advice to, you know, in your case, macroeconomic policy makers, in my case, you know, mayors what should we be doing differently about that? How should we be thinking about that? What’s, what’s, what’s, how should economics be different along this margin?

Larry Summers:

So I think Ed, it’s another very good question. I think there are two ways of seeing it. One way to which I used to be more partial was that, you know, economics is losing its way into esoterica. It’s turning itself into a branch of applied mathematics. Isn’t that kind of unfortunate? And that was the way probably if you had asked me about this 15 or 20 years ago, 25 years ago, I would’ve tended to give an answer like that. I think today I would give a different answer. I think today I would describe it as part of the process of greater specialization. If they were trying to figure out how a suspension bridge would operate in 17th century England, it would’ve been reasonable to consult with Isaac Newton, cuz he was a person who really understood forces in a very good way and could perform calculations.

Larry Summers:

Today’s world has physicists and it has engineers. In the 1960s, there would’ve been a number of academics who would’ve been among the first 10 phone calls you would’ve made if you wanted to make a judgment about GDP growth over the next two quarters that followed all the statistics and was aware of all the indicators. Today, there’s no academic who would be who you would turn to. There are a set of people working in various financial institutions who are much more on top of all of that information. So I think what we’re seeing is a pattern of increased specialization, which is in a way sad because one likes to think of there being great renaissance people who can be at both the cutting edge of science and the cutting edge of practice. But it seems to me that as the world gets more complex, it’s inevitably going to be the case that there is going to be some greater division of labor.

Larry Summers:

And I think that’s probably something that is all right. It doesn’t explain why the more applied branch of our profession, the kinds of economists who make these forecasts writing for the large forecasting firms like macroeconomic advisors or writing for Goldman Sachs’s clients, did such a bad job, which is, I think still a question. But my assumption would be that over time there’s going to be greater and greater division of labor. I meet economists, I meet students who kinda wanna have a career like the career that I’ve been lucky enough to have and want to get advice. And you know, I sometimes tell them different things depending upon what their mix of interests and aptitudes are. But I think there is this, I think it’s good to have cutting edge science around economics. You know, in a way to use a different analogy, I think that there is a much greater cleavage than existed 75 years ago between the theoretical physics community and the community that provides advice on arms control strategy.

Larry Summers:

And I think that’s mostly for the better. I think the theoretical physics community is often unwise when it, and impractical when it provides advice on arms control. I think some of the things that you have to understand to be a theoretical physicist, you don’t have to understand to think sensibly about arms control policy or weapons systems. And I think something of that kind is going on within within, within economics, I do think there’s a bit more percolation from the science through to the policy, just with significant lags. And I kind of think that that is okay. My guess is that in, to take your area Ed 30 years from now, there will be economists who are thinking in fundamental ways about glomeration and there will be economists who are advising mayors and those communities will be less overlapping than they are today.

Larry Summers:

And I think that’s what we call progress through the division of labor. That’s, that would be my interpretation. So I am reluctant to challenge the, some of the requirements and some of the expectations that are around the scientific socialization that you describe. I think over time it will be incumbent on the academic enterprise to find ways to train people to be good at making the kinds of decisions that treasury secretaries make. But I don’t think that that necessarily means that the training that’s being provided to people who wanna be lab scientists or scientists types should be modified.

Ed Glaeser:

I’m also not sure in terms of the life cycle, right, it may well be that we wanna train our 24 year olds to be lab scientists and then have something that enables people to age gracefully into being more policy oriented people. That would be a program at the NBR or something, something like that. I wanna ask one slightly impish question, right, which you have to have to forgive me for it. Do you regret, when we go back to this, to your column in on February 4th, do you regret ending the column by saying that Biden plan is a vital step forward? I mean it’s a, it’s a fairly clear endorsement despite the fact that you were, you know, going out on a limb in terms of pushing against the the risks of inflation. Do you wish you had been less less prone to give it an endorsement? At the end of the day?

Larry Summers:

It, it says something interesting about how that column was read. That I have participated in probably a hundred discussions of this type in the last six or six or nine months, and you were the first person to ask that question, <laugh>. So I think it’s safe to say that my endorsement was less than highly consequential, nor was it seen by some of my friends who did not appreciate the column as a very substantial saving saving grace. I think I’d say two things in all honesty Ed. One is that I think there is a question as to whether zero, I’m sure I think 2 trillion was too much. I think, I think in all honesty, I think in retrospect, zero probably would’ve been a better number than 2 trillion. But on the basis of the information that I had at the time, I don’t think that was true.

Larry Summers:

And so I think my statement was actually a kind of reasonable one. And I think that there is a balance that one has to strike and that I’m constantly sort of mindful of striking, which is one has to, it seems to me that if one is writing for the broad audience and the broad community and the broad policy process, one has to balance articulating what one sees as true, which, what’s the point if you’re not doing that and providing information that can guide and providing direction with creating a capacity for one to be heard, right? And that I, I make no apology for the fact that that influences what, how i, how I write things. And so in all honesty, I think I would not have withdrawn that pa I don’t think I made a mistake by including that including that sense.

Ed Glaeser:

Totally reasonable. Okay, so two elements in inflation that sort of push pushes in slightly different directions. So one is housing. Housing is likely, if anything, and I’d like you you to explain this cuz you’ve, you’ve written it on this, it’s likely certainly not to go away anytime soon, the housing component to inflation. If anything, it might even even increase. The second is oil. Oil has a direct component which is taken out in the core inflation numbers, but there are also indirect components that oil has throughout the economy. And we have a a, I’m gonna give a, a un unashamed plug for our PhD student, Robbie Mitten, who has a very nice job market paper on how you filter out oil, which gets you, you know, maybe perhaps one fourth of the burst in inflation can be, or the combination of the direct and indirect effects. And at least, you know, when I look at the oil futures markets, it looked like this looks like people think that oil is gonna mean revert somewhat. So that’s likely to be a slightly cooling force. How do you think about oil versus housing? How do you, you know, which, and there’s a lot that’s wrapped up in that both, both this sort of, you know, role of supply chains and oil or role of the war and oil and, you know, looking forward.

Larry Summers:

So let me say something about housing first and then say something. Oh, well with respect to housing, there is a question whether in measuring prices, you should measure the prices that people pay or are paid, or you should measure the new prices that are struck. So every month most people pay the same rent they paid last month, and a few people have a new lease. And if you look through 2021 and the first few months of 2022, very clearly new leases were going up by 15%, but most people were not getting new leases. And so how should you measure the rate of inflation? The CPI averages in with low weight, the 15% who are getting new leases, and the vast majority who were paying the same amount they paid last month. What that means is that even after new leases stopped going up, the CPI is gonna be going up for a quite substantial length of time.

Larry Summers:

So even if new leases only go up at 2%, annual rates from here at the end of 2023, housing inflation in the CPI will be running at six to 7%. And in the core cpi, even if everything else was zero core CPI would be running about two and a half to three percent. So those are the facts. And then there’s a question as to how you should interpret them. I’m inclined to give, I’m inclined to think that the CPI does it a reasonable way. So for example, when we look at wage data where the same phenomenon happens, most people have the same wage that they have last month. That’s certainly true for you and me at Harvard, but after a year or so, people get Wage Inc. But people get their salaries adjusted once a year unless they move jobs. So there’s a case just like the case with respect to housing, that you should look at the people who are moving jobs to figure out where the labor market is going. I find it interesting that not a single one of the people who go through all this analysis and then conclude that inflation is low because new leases are not going up. Not a single one of them pays any attention to the fact that the gap between job switchers and other workers is at a record high right now suggesting the likely acceleration of, Can

Ed Glaeser:

You, Larry, can you explain that? I’m not sure that, that that was clear. What, what defined what you mean by the gap between job switchers? And

Larry Summers:

So you can look at what happened to wages averaged across all Americans, or you can look at what happened to the wages of the people who switched jobs last in the last few months. Usually those two things move together. We’re at a moment right now when there’s an unprecedented gap between those two things. What that tells me is that the labor market is very tight, that there’s a lot of wage pressure, that when Harvard hires a new professor, they give that new professor a big premium wage and that over time the wages of people like you and me will catch up. So that tells me that we have a lot of wage inflation to come just as the core logic or the private sector. Rent indices last year told me that we had a lot of housing inflation to come. I understand the logic of people who say that this year, private rents are no longer going up, new leases are not going up so fast, therefore we shouldn’t worry so much about housing inflation.

Larry Summers:

The problem is that the same logic says we should worry more about wage inflation, and none of them are intellectually consistent because almost all of them are politically motivated by a desire to push for easier policy. And I think one of the ways in which our profession has not distinguished itself is the strong correlation between people’s technical judgments and their political loyalties ed oil’s a really interesting question. I am struck by the disjunction between the forward market judgment that you describe and which I share, which I share as being an accurate description and the view of what I would call the Dan Jurgen set, the set of people who count barrels follow the oil markets very closely, and who tend to see substantial li substantial risk of oil price inflation from things like the Saudis and the Russians. Now of course, the market knows all that, and so one can just say, follow the market.

Larry Summers:

I think a difficult question is what is the demand estimate that is implicit in the market’s view? And many who are close to the markets tell me that the reason why the market is forecasting a decline in oil prices is that they’re factoring in a lot of demand suppression from recession in the next year. I don’t know whether that’s right. There’s a small technical factor that explains this, which is there are many more oil producers who want to hedge by selling forward than there are oil consumers who want to hedge by buying forward. And that means that there’s a tendency for the price to be low. I don’t think that’s, I think that’s a few dollars, That’s not $20. And so I think there is still a question about oil. Last thing I would say is you referenced one of your students papers, which I’ve not had the privilege of reading in general, I think almost all analyses that call themselves supply side analyses and focus on single markets are likely to confuse more than they illuminate with respect to inflation for a variety of reasons.

Larry Summers:

One of which is when the price of gasoline goes up and people still have to drive to work and they spend more money on gasoline, they spend less money on anything, on everything else, which in a small way, but attached to a large number of products, reduces the demand for those products and therefore reduces their price. But nobody’s saying what the effect of the gasoline price increase is ever factors into its contribution to overall inflation, The deflationary impact it has on a large number of other sectors. So in general, I would caution your listeners that for many phenomena, a macro view is better than a micro view. Another example is people forecasting stock market earnings. The people who do it on a company by company basis almost always miss all the big moves because the big moves are associated with recessions and the like, and often the people who forecast total earnings better are the people who try to forecast what’s gonna happen to the overall economy and then think about total profits relative to the overall economy. And I think something similar is true with respect to inflation,

Ed Glaeser:

Very, very wise. The your comment about oil price drops during recession reminds me of course of this, this great urban fact that the Empire State Building came in 25% underestimate because the cost of of steel dropped so much during the, during the Great Depression before turning to the audience, I’ve, I’ve gotta ask the question that I think, you know, everyone wants to know how, how long and how high does the Federal Reserve have to keep rates? What’s your, what’s your, either your expectation or your suggestion and what’s your openness to other forms of policy that might impact inflation? Be it fiscal policy or, you know, the unorthodox tools touted by some other advocates?

Larry Summers:

I think price controls and the like are almost always failures, and I see nothing in favor of them. I think that the idea that inflation is caused by gouging and we should stomp on gouging, I don’t think is a productive avenue. Though I do favor more aggressive antitrust policies on long, on on long run reasons. I think there are a set of positive supply side things that would be good to do anyway and are probably extra good to do at a moment of substantial inflation. It should not be forgotten that the somewhat unlikely coalition of Jimmy Carter, Edward Kennedy and Steven Breer brought about airline deregulation in the context of the inflation of the 1970s. And so when I look at the degree of restrictions that there are on permitting for energy, both renewable and non-renewable, when I look at the unproductive tariffs that we have in the United States that are adding perhaps 2% to the price level, when I look at restrictions and rules like the Jones Act or the limitations on the number of medical residency slots that are available, or, Oh,

Ed Glaeser:

Larry, sorry to interrupt. We better explain what the Jones Act is. It’s a, it’s a, you know, I hate it as much as you do, but at least we should, we should

Larry Summers:

Define the Jones Act is a set of rules that basically say that a foreign ship cannot take oil from Houston to Newark or other products, and that make the price of everything in Puerto Rico and Hawaii much more expensive and make things much less reliably provided than they otherwise would be. You know, another exam. Another example is when British Airways flies from London to Boston to Los Angeles, Is there any imaginable reason why it shouldn’t be permitted to pick up American passengers in Boston? There are a lot of examples of that kind, and this would be an opportunity to go after them and it would make some contribution with respect to inflation. My strongest conviction, a is that based on the experience of past business cycles, unfortunately as Samuel Johnson said of second marriage, soft landings are represent the triumph of hope over experience.

Larry Summers:

And the likelihood is that we will not bring inflation down sufficiently, substantially to get near the fed’s 2% target without a period of inflation, without a period of unemployment that I think is likely to be six to the nearest round round round number. And I think that awareness has not fully permeated and the fact that it hasn’t probably is reducing the credibility of efforts to bring down inflation. My best guess would be that the market’s current judgment, which is that the terminal rate will need to be 5% on fed funds is considerably more likely to be too low than to be too high. And so my guess would be somewhat higher than that. But I have higher confidence in the view about the degree of slack that is necessary to reduce inflation than I do about the level of interest rates that is necessary to be associated with disinflation. My guess is that there’s more room relative to what’s priced into markets. I think already the feds September doc plot is looking to obsolete in light of the subsequent economic numbers.

Ed Glaeser:

Great. Okay. Now I’m gonna pivot to questions that we received. So this one is a directly linked to what you just said. So here’s, here’s the quote, Alan Blinder argues, Most past landings have been soft, so this one likely will be two. Is this one like the others or not? My interpretation of what you just said is yes, it’s likely to be like the others, but most landings have not been soft. They’ve been hard. Is that, is that

Larry Summers:

Allen Blinder’s claim of that kind, I think has no relevance to the current situation. Examples of the soft landings, he sites are the soft landing, starting with two and a half percent inflation in 1993. None of the soft landings that he sites began with inflation in excess of 5%. All of the instances he reviews in his very thoughtful history in which inflation was above 5% involved hard landings. So I don’t think there is anything in that history to support the view that we will now be able to organize a soft a soft landing. If you asked me to make the best case for that proposition, it would not involve anything about the fed and soft landings. It would involve other periods like wars when pri when there was substantial inflation and the world came subsequently to see it as a one off increase in prices rather than as an inflation problem. I don’t think those examples have much relevance to today, but if I had to defend the counter proposition to mine, that would be what I would, those would be the kinds of arguments I would make. I think it’s simply absurd to suggest that there’s relevant history of fed engineered soft landings. The better argument for extreme optimism is to still claim to team transitory that the inflation is gonna recede on its own.

Ed Glaeser:

Great. this, this one you’ve already mentioned both the, the, the wages for new hires and new leases, but surely there are other measures which would be relevant in answering this question. What particular indicators or metrics are you monitoring that might lead you to assume that core inflation has peaked? So that’s the, that’s the question is what, which, and I presume there are many of our listeners who’d be interested in knowing. What other things do you think are important that make you, you know, would make you think that we’ve turned the corner beyond wages for new hires and leases for new rental rates for new leases?

Larry Summers:

So I would, so I look very hard at measures of labor market tightness. I look at the vacancy rate, I look at the quits rate because when labor markets are tight, more people quit. I look at measures of capacity utilization because those have something to do with how much firms are likely to feel pressure and the ability to pass on cost increases. So those are some of the measures I look at. I also would be paying atten paying attention to measures of inflation expectations. And I would be paying attention to the various measures that are produced by the different regional federal reserve banks that look for example, at sticky price components of the CPI versus flexible price components, or look at the median CPI component rather than looking at some average or look at what’s called the trim mean picture.

Larry Summers:

I think one of the things one has to do to be intellectually honest in these things is look at a wide range of indicators. Always be constructing in one’s own mind, the best case that the position one holds is wrong. And then see how credible and convincing you can make that case. It’s partially responsive. Perhaps to your question, add to remark that one discipline I use in forecasting and that I find quite helpful is if my, if I think my forecast is going to be of 4% core inflation, I say to myself, all forecasters are always, are almost always wrong. And so I say a year from now, which is more plausible that we will have had 6% inflation or that we’ll have had 2% inflation. And unless those two things are in equi poise, I revise my view about 4% inflation. And I think many of the forecasts one hears these days have actually more the character of best reasonable case than the character of best judgment.

Larry Summers:

It’s not that it’s unimaginable that inflation will be as those forecasts have it, but if you actually really forced those who were making the forecast to judge the probability of their being substantially low and substantially high I don’t think that they would be able to reach any conclusion other than that they were at more risk of being low. So, for example, another sentence I often hear from economic forecasters is, My forecast is X, but the risks are mostly to the downside <laugh>. I would say, Well, why is that your forecast then? If your forecast is that your forecast is gonna be wrong, why don’t you change your forecast? And so my forecasts may be no good, but they tend to almost always to have the feature that the downside risks and the upside risks are roughly balanced because that’s how I reached by forecasts.

Ed Glaeser:

Right, right. Do you think that this is, again, coming from the field, do you think we’re gonna get to a point in which real rates are actually positive? So

Larry Summers:

Look, I think the, the, the problem about that is that real rates are a less well defined concept once one engages in the world than they tend to be in theory. Is the har are we talking about rates for the next three months, rates for the next year, for the next five years? Are we talking about inflation as measured by the GDP deflator? It’s measured by this deflator as measured by that deflator. I, it supports my general line of argument, but I think this real rate thing has been a bit overdone by the fed’s credits. I get an email every morning from the intercontinental exchange in which they report to me based on the derivatives they trade, what the prevailing estimate is of one year, real rates and of five year of the five year real rates starting one year from now.

Larry Summers:

Those numbers are positive right now. Mm-Hmm. <Affirmative>. So there are concepts of the real rate where we are already positive. I already expressed the view that I think we’re gonna have to raise rates more, and since we’re gonna be raising rates and inflation, probably by middle of next year, we’ll come down at least some, I think we’re gonna be moving towards higher real rates than we have, than we have now. But I think it’s a little bit fast to simply say the Fed funds rate is three, inflation has been seven over the last year, therefore we have obviously negative real rates that while it supports the direction, which I’d like to see policy move, that seems to me a bit fast is an argument

Ed Glaeser:

That that sounds right to me. You know, the way that I’ve typically thought about this in the housing context is, is I think as you, as you comment, suggested comparing something like a, a 10 year, 10 year rate to the 10 year Livingston expectations for, for, for which is a survey of forecasters. And that number of the 10 year inflation expectations is currently two and a half percent. So as you say, that is, we do currently have positive real rates in that, in that dimension. The moving on to the next, the next question. What do we think about the inflation reduction Act and its actual impact on inflation? I think you, you actually played a role in terms of, of public discussions about this, but it, it’s a question that one of our, one of our seminar participants asked.

Larry Summers:

I don’t think inflation reduction act was a good thing. I think that it spurs renewable energy technology in a way that is quite desirable. I think it corrects over, it corrects a decade of staggering underinvestment in the IRS and enables us to have a more functional tax administration system, which for a country with a $7 trillion tax gap over the next 10 years, $7 trillion is I think, an important thing. And I think it does good some good things with respect to widening access to healthcare. And I think the best guess would be that over time it is going to reduce budget deficits. So I think the support that it provides to energy supply and the reduction in budget deficits means that the path of inflation, other things equal, is likely to be slightly lower with it than it is without, I don’t think it represents a major solution to inflation. But unlike some of the early proposals, which I think would’ve quite substantially exacerbated inflation pressures as obviously the rescue Act did I think this one is on the right side of the ledger. I don’t think that it was the greatest truth in advertising to label it that I think the right label for it was the renewable energy investment renewable energy investment, healthcare broadening and IRS strengthening Act. But I do think it will have the effect of reducing inflation

Ed Glaeser:

Great. In the, in the live chatroom. Tom Palmer writes, a local economist told me recently that quantitative easing and tarp had nothing to do with the runup in equity and real estate prices since 2007 when otherwise inflation was flat. He blamed only low interest rates. Do you agree?

Larry Summers:

I think low interest rates get, I think, I think most market participants put more weight on QE relative to the level of interest rates than I would. So I would agree directionally with the statement, but I certainly think that QE and price pressure effects do matter. One of the more interesting phenomena in the economy that you probably understand better than ied that I think is worthy of attention is the quite substantial variation in the spread between mortgage rates and treasury rates. And you know, over the last years in round numbers treasury rate, 10 year treasury rates have gone up from one and a half to four. That’s two and a half percent mortgages have gone up from three to seven. That’s 4%. What are the reasons for that difference? Some of it has to do with volatility, which makes for the financially oriented here, the option value of 30 year mortgages greater, but I don’t think that’s most of it. And a fair amount of it, I think does have to do with the kinds of price pressure effects that are implicated in QT and qe. So my bottom line answer is direction you were told directionally, right. But I wouldn’t make nearly as bold a statements as your interlocutor did.

Ed Glaeser:

Great. I have two questions. I’m actually gonna end on observations on the uk. But before that, I, I think this other question in the chat room is, is interesting and probably worthwhile sort of pointing out some things about the way that credit markets work that, that this question sets off. So the idea is why doesn’t the Fed keep interest rates low for borrowers like first home mortgages, cars, small local businesses, government infrastructure and education, and raise it for large corporates and those who also borrowed to protect their cash flow? Okay, so that was the question was can the Fed do more to differentiate between different types of borrowers with, with its whatever its monetary policy is doing,

Larry Summers:

Not without being awfully socialist in a way that is pretty problematic. What’s to stop me from borrowing money against my house and then putting it in a bond fund that invests in general motors bonds? If something like that is underway in general capital will tend to find its way to the place where it earns the highest yield. And if you try to interfere with that, you’re likely to end up with very substantial set of controls, very substantial repression, and a lot of distort a lot of distortionary effects. In the 1960s. We kind of tried your idea. We had this idea that there were these institutions oriented to housing savings and loans, and they had a maximum interest rate that they could pay on deposits and that would hold down the mortgage rate so that there would be cheap capital available for housing. And what would happen is when the Fed raised rates, they would lose all their money and there wouldn’t be any funding available for housing. And housing would crash in a particularly brutal way. And I think most economists think it was progress that we’ve moved beyond that. So insofar as we wanna subsidize particular things, I’d rather see us do it with direct government subsidy programs or with tax incentives than do it through the selective provision of credit.

Ed Glaeser:

Right. The important point being, we really want to have government subsidies be clear and visible and understand what the cost will be, as opposed to doing them in a veiled way where we have no idea how many of these loans are gonna go go bankrupt. Okay, last question. The actual question was how important is the pivot in the UK to the world economy? But I want you to just, if you, if you’re willing just to like give us two minutes worth of observations on the UK on where are they going, what’s, what’s happening? How should we think about this and how should they be doing it better? So

Larry Summers:

Look, it was a perfect store. They had a weak central bank. They had profoundly important supply shocks that were being inflationary. They had committed themselves to extremely expensive energy subsidies. And then you had a new government that decided it was going to surprise everybody by announcing massive tax cuts that caused everybody to wonder whether Britain was a banana Republic or not. The, when people wonder whether, whether you’re a Banana Republic or not, what they do is they sell your bonds and they sell your currency. So anytime you start seeing a pattern where in a country it’s long term interest rate is going up and its currency is going down, that’s a moment to be very nervous. The authorities reacted sluggishly and inadequately to all of that. Then there was an additional problem, which was that many of the pension funds had in effect speculated in the bond market.

Larry Summers:

So when the bond yields went up and the bond prices went down, they got margin calls and they were forced to sell, which drove the whole thing into overdrive. More higher yields, more selling, more selling higher yields. At which point the British authorities have had to kind of do something like it was from a Saturday Night Live skit. Oops, we didn’t mean it. And the prime minister who actually had meant it and had driven the policy is still there in office but not in power, having seated most power to her secret to her chancellor. The X checker in effect, the Secretary of the Treasury, the Bank of England is kind of confused as to whether it’s tightening monetary policy cuz it has a lot of inflation or whether it’s printing money and buying bonds because the bond market’s in trouble. So the situation is kind of exuding disarray. There is a modest effect from the fact that British investors who need liquidity are divesting foreign securities as well, and that’s affecting the global economy. There is a larger effect which one might call a reputational externality that, gosh, if this could happen in England, maybe it could happen in other places. Maybe we need to be more suspicious. Which is, I think, adding to risk premiums everywhere. I think that those effects are there. I don’t think those effects are immense.

Ed Glaeser:

Great. Thank you Larry. You’ve been very, very generous and I I, we’ll just, we started earlier in, in the conversation talking about how people trained as, as economic scientists learned to be worldly philosophers. A non-trivial part of my education in this has been talking to you and listening to you over the last 31 years and the last hour was, no, no different. You, you remain a, you know, a model of this and just a tremendous example of how to actually use wisdom and knowledge to in fact make the world a better place by advising, advising its leaders. So thank you for your time, Larry, and thank you for all of our, our program participants. I believe this webinar has had an end.

Larry Summers:

Thank You.

Joe Selvaggi:

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