By Mark Weisbrot*
Larry Summers says he’s worried about the US economy, even more so than he was when he started sounding the alarm bells in February. The famous economist and former US Treasury Secretary noted last week, “the concern right now should be overheating”.
He is not talking about the climate, but about the economy growing too fast and facing persistently high inflation like in the 1970s, as well as other possible crises. On the same day it issued the warning above, the consumer price index (CPI) for June was 5.4% above its level a year earlier. News reports noted it was the biggest one-year jump since 2008.
There are many reasons to wonder if his fears are well founded; more on that below. But first, some background on why this debate is so important at this particular time in US history.
Most of the time in the United States, the two most important policies that determine people’s standard of living over time – including employment and unemployment rates – are monetary and fiscal policy.
Monetary policy is decided by the Federal Reserve, which sets short-term interest rates, and currently also directly influences long-term rates (including those paid on mortgages). Over time, the Fed’s interest rate policy is the most important policy in determining the level of employment and unemployment that we have. This is due to the effect of interest rates on economic activity – for example, note the recent boost the housing market has gotten from low mortgage rates. Importantly, the Fed has generally raised interest rates when it decided that unemployment had gotten “too low,” thus setting a limit on how close we can get to full employment.
Fiscal policy is the government’s use of taxes and spending, including some of the federal spending since the start of the pandemic/recession that served as both relief and stimulus. It can also significantly boost employment, especially during a recession or when the economy is recovering.
As my colleague Dean Baker and Jared Bernstein (currently a member of Joe Biden’s Council of Economic Advisers) explained in their book, “Return to full employmentas the economy approaches full employment, there are not only millions of additional jobs, but also substantial reductions in income inequality. Low-wage workers see their wages and jobs increase more than those higher up the income ladder; the same is true for black workers versus white workers.
Historically, our government institutions, including the Fed, have been far too conservative to allow the economy to achieve full employment. The Fed has actually caused most recessions the United States has experienced since World War II by raising interest rates.
As far as fiscal policy is concerned, the federal stimulus during the Great Recession, for example, was much too small to compensate for the shortfall linked to the bursting of the real estate bubble. It was only 2% of GDP, less than a quarter of what was needed. And about half of that was negated by state and local government budget cuts.
So it’s a historic achievement that, as Summers complains, the U.S. government has a projected deficit of 13.4% of GDP this year (after 14.9% last year). And current Federal Reserve Chairman Jerome Powell has demonstrated a greater commitment to full employment than perhaps any other Fed chairman. Unemployment is currently at 5.9%, with millions more unemployed than the 3.5% rate reached before the pandemic.
As we have seen since the 1990s, fiscal and monetary policy limits have turned out to be considerably less constraining than what economists and policymakers had maintained for decades. Even in the recent past, the Fed lacked its current commitment to full employment; and Congress and the President would never have approved the kind of spending he has recently implemented, in order to alleviate suffering and hasten economic recovery.
There is another pressing part of this story: the next two elections could very well determine the next decades of American politics and life, including whether the current system of minority rule may persist. Readers here will know what I’m talking about: voter suppression, gerrymandering, the Electoral College, the Senate (with filibuster), and the Supreme Court. And other institutions and laws that allow Republicans to hold national power without winning a majority of voters.
The implementation of these two most important – and often misunderstood – economic policies could very well decide which party wins the next two elections.
Which brings us back to Larry Summers, who met with two of Biden’s top White House economic advisers on the same day last week. His argument is about the extent of both fiscal and expansionary monetary policy – that is, the Fed’s zero short-term interest rates plus money creation (“quantitative easing”) and the very large federal budget deficit. Together he saidthese will push the economy beyond its potential GDP and bring us inflation out of control.
Of course, economists recognize that there are limits to what can be done with fiscal and monetary policy, but most do not see the current explosion in inflation as evidence of an imminent threat. As Dean Baker underline, more than half of the 0.9% increase in the CPI in June was due to cars. There is no reason to think this will continue, as it is the result of post-pandemic shortages (eg, semiconductors) and pent-up demand. Part of the increase in annual inflation, including in recent months, is an artifact because current prices are compared with with prices depressed by the pandemic a year earlier.
Nor is Summers’ comparison to the 1970s convincing. It took many years in the 1960s and 1970s to change people’s expectations of inflation. And there were major oil shocks, as well as stronger organized labor, often with cost-of-living allowances that kept their wages rising with inflation.
The Wall Street Journal’s latest survey of economists, reported this week sees US GDP growth peaking at an annual rate of 9.1% for the second quarter, and declining to 3.3% for the second quarter of next year.
And for now, as Fed Chairman, Powell Noted this week, “measures of long-term inflation expectations have risen from their pandemic lows and are in a range that is broadly consistent with the FOMC’s long-term inflation target.” The bond markets agree: the interest rate on 10-year bonds fell to 1.2% this week. They don’t seem shaken by the latest CPI report. Or by the arguments of Larry Summers.
We can already get a glimpse of what this society might look like if these changes in economic policy boundaries are not reversed, for example, with the expansion of the child tax credit, which, if made permanent, should reduce child poverty by about 45%. The future of the country is at stake; not only our economic and social progress, but — because the economic results of the next few years could well be politically decisive — the fate of our democracy.
*Mark Weisbrot is co-director of the Center for Economic and Policy Research in Washington, DC. He got his doctorate. in Economics from the University of Michigan. This article originally appeared in The Guardian