The Federal Reserve will need to lift interest rates higher than the market expects and warned that a recession could be a potential consequence recently told by Former Treasury Secretary Larry Summers. In an interview with CNN, Summers stated that the U.S. does not “have inflation on a secure glide path anywhere near down” to the central bank’s 2% goal, and that the Fed will need to tighten until it can be confident of that.
Summers predicted that interest rates could hit 5.5% or higher, with 6% not being out of the question, which is higher than the range of the Federal Reserve’s benchmark interest rate, which is currently set at 4.5% to 4.75%. He stated that anyone who thinks rates won’t go that high is “making a real mistake given all the uncertainties that we have in our economy right now.”
Summers also noted that historically, there has been a tendency to not achieve soft economic landings when inflation is significant, and that the process of bringing down inflation could potentially bring on a recession, as it has in the past.
In economics, a soft landing refers to a scenario in which an economy transitions from a period of growth to a period of slower growth or stability without experiencing a recession or significant economic contraction. It is a gradual slowdown that avoids a sharp and sudden decline in economic activity.
On the other hand, a hard landing refers to a scenario in which an economy experiences a significant and rapid slowdown, often resulting in a recession or economic contraction. This can be caused by a variety of factors, including high inflation, rising interest rates, excessive debt levels, or a sudden drop in demand for goods and services.
A soft landing is generally considered a desirable outcome, as it allows an economy to adjust to changing economic conditions without experiencing significant disruptions or economic hardship. A hard landing, on the other hand, can be more challenging to manage and can result in job losses, business failures, and other negative economic consequences.
Central banks and policymakers often aim to achieve a soft landing by implementing policies designed to manage inflation, balance economic growth, and promote stability. However, predicting and achieving a soft landing can be challenging, and there is always the risk that economic conditions will deteriorate, leading to a hard landing.
While Summers’ projection is just a “best guess,” it comes at a time when there are growing concerns about inflation and the potential for the Fed to raise interest rates. Federal Reserve Chairman Jerome Powell recently stressed that central bank policymakers are prepared to raise interest rates higher than previously expected and pick up the pace of increases in the face of hotter-than-expected economic data.
It’s important to note that no one knows for certain what will happen with interest rates and the economy in the coming months and years. However, Summers’ warning serves as a reminder that individuals, companies, and policymakers should be prepared for a range of possibilities, including a potential recession. As Summers stated, “hope for the best but plan for the worst” is the right advice for everyone.
Further, A recent paper authored by a group of leading economists shows that history suggests that it is hard for central banks to achieve disinflation goals without a significant sacrifice in economic activity, i.e., triggering a recession. The paper identified 16 periods since 1950 of “disinflation” orchestrated by a central bank in the US, Germany, Canada, or the UK, and in each scenario, a recession resulted after the central banks raised interest rates.
Although Fed policymakers are counting on finding that elusive sweet spot, known as a soft landing, the paper warns that such an immaculate disinflation would be unprecedented, and achieving it is difficult without a significant sacrifice in economic activity. The findings have elicited pushback from Fed officials, who maintained that a soft landing is a feasible outcome. The Fed last month voted to raise its benchmark interest rate to a range of 4.5% to 4.75%, and signaled that a couple more increases are on the table this year.
In conclusion, Former Treasury Secretary Larry Summers has warned that the Federal Reserve may need to raise interest rates higher than the market expects to manage inflation and achieve its 2% goal. He predicts that interest rates could reach 5.5% or higher, with 6% not being out of the question, which could potentially trigger a hard landing or recession.
While achieving a soft landing is desirable, history suggests that it is difficult to achieve without a significant sacrifice in economic activity. The recent paper authored by leading economists highlights the challenges of achieving disinflation goals without a recession. Although the Fed officials maintain that a soft landing is feasible, it’s important for individuals, companies, and policymakers to be prepared for a range of possibilities, including a potential recession.