The Scene
This time last year, Larry Summers was arguably the chief pessimist of the economics world. In order to beat inflation, the former Treasury Secretary argued, the U.S. would have to swallow a long period of high unemployment — something on the order of a 10% jobless rate for a year, or 5% for five years. But now, with the job market still humming, inflation seemingly cooling, and talk of a soft landing growing louder, I wanted to catch up with Summers about how he has or hasn’t adjusted his outlook, as well as some of his other recent warnings about the Biden agenda.
The interview has been lightly edited for length and clarity.
The Interview
Jordan Weissmann: We’ve just had our second month in a row of “unambiguously good” inflation data, as your friend Jason Furman put it. But you’ve said it’s premature to declare victory. What sign are you looking for that we’ve beaten inflation? What would make you satisfied?
Larry Summers: I think I would want to see a few months of positive figures. I would want to see clear evidence that wage inflation was receding to levels that were consistent with the Fed’s 2% inflation target. Most recent wage inflation figures show inflation more for the month than the quarter, and more for the quarter than for the year. And I’d want to see, before feeling that everything was okay, that declines in inflation were not coming along with declines in confidence so rapid as to set off a recession. I certainly think a soft landing looks more likely than it did six months ago. But I’m not prepared to bet on a soft landing.
Jordan Weissmann: When we talked a year ago, you were arguing — based on what I think were some pretty textbook economics — that we might need a year of 10% unemployment to bring inflation down to the Fed’s target. At this point, do you feel comfortable saying that’s probably not the case, and if so, why do you think it turned out to be wrong?
Larry Summers: First of all, I said that we would need a protracted period of slack, and it could take multiple different forms. I think looking at inflation dynamics, it appears that the natural rate of unemployment may be lower than had been my guess at that time [Ed. note: That’s how far unemployment can theoretically fall before it causes inflation to accelerate]. And I think that the underlying rate of inflation might have been a bit lower. And it may be that the Phillips Curve is a bit steeper. But I still think there are real stagflation risks. I will be not shocked, but pleasantly surprised if inflation stays in the broad 2% range over the next several years without having had a meaningful recession.
Jordan Weissmann: What is most surprising to you about the economy right now?
Larry Summers: I’m surprised that inflation has been as restrained as it has been with a variety of demand measures still looking quite strong.And I’m a bit surprised that the economy has been as robust as it has in the face of interest rates as high as they are.
Jordan Weissmann: Do you have any theories about why that might be the case?
Larry Summers: With respect to the robustness of the economy, it’s a combination of two things. It’s a combination of neutral real interest rates having risen, because of budget deficits, because of energy and resilience investments, and because of the accumulation of savings after COVID. [Ed. note: At the “neutral” rate of interest, the economy can theoretically maintain full employment and a constant rate of inflation]. And I think it’s also a reflection of reduced interest rate sensitivity of spending, as a larger share of the capital stock has become goods like iPads instead of goods like new factories. And interest rates, by raising payments on government debt, having started adding substantially to disposable income.
With respect to the robustness of inflation, given the strong economic activity, I think it’s because the Fed, after allowing itself to get way behind the curve in 2021, has been very strong and resolute in its emphasis on the 2% inflation target, and on the centrality of price stability as a goal. And has largely taken the advice of those who were more hawkish in believing that it’s more important for the Fed to invest in credibility by raising rates.
Jordan Weissmann: So you think the Fed cleaned up its act just in time.
Larry Summers: I think I’ll use my language rather than let it be recharacterized.
Jordan Weissmann: You recently called Joe Biden’s economic policies “increasingly dangerous” because they focus on encouraging domestic manufacturing instead of free trade. I’m curious: Do you really think it’s a bad idea to encourage clean energy manufacturing and semiconductor production at home, given the national security concerns around China.
Larry Summers: I have said many times that I supported both the IRA and the CHIPS Act, and I worked hard to promote the passage of the IRA.
Jordan Weissmann: Right. That’s where I’m a little confused…
Larry Summers: What I find problematic are the broad doctrines put forward rejecting the trade approaches of the last 40 years, calling for an emphasis on manufacturing and “buy America” as centerpieces of policy and suggesting that reduced global integration is a passport to prosperity.
Jordan Weissmann: I don’t want to belabor it, but I sense a little bit of a tension there, because the IRA was so focused on American manufacturing and had so many “buy American” provisions that were essential to getting it over the finish line. And at the same time, you’re hesitant about that…
Larry Summers: The important part of the IRA was the very substantial commitment to the climate change issue that it represented. The implication that somehow its provisions were so good that even if climate change didn’t exist, we’d be more prosperous by pretending that it did was quite dangerous.
The strong case around the IRA and CHIPS was around their contribution to the environment and national security, not around their direct contribution to making us more prosperous.
Jordan Weissmann: Now for something totally different. You recently wrote a really interesting response to the Supreme Court’s affirmative action decision. [In brief, while he disagrees with the Justices’ ruling, he thinks schools need to begin focusing on recruiting socially and economically disadvantaged students, both by offering a leg up in admissions and by eliminating policies like legacy preferences]. And I’m curious what you think the chances are that any schools are actually going to follow your menu of suggestions.
Larry Summers: I’m an optimist, and my guess is that the trends will be in the right direction on policies that are more focused on opportunity. I would be surprised if elite institutions moved as aggressively on my full suite of recommendations as I would prefer.
Jordan Weissmann: Do you think Harvard would ever get rid of legacy admissions?
Larry Summers: It’s for the current leadership of Harvard to speak to Harvard’s policies. I hope that acting together, the Ivy League moves past legacies.