EDITOR'S NOTE: Midterm election optimism continues to fuel the broad-based market rally. Still, regardless of what voters are expecting, the results and their correlation to the markets remain unclear. A largely Democrat victory would leave current conditions unchanged. But even if Republicans were to take control of Congress, there aren’t many things that Republicans can do to change the economic factors that are generally beyond fiscal and even monetary control. One thing that’s certain, however, is that the Fed will remain aggressive in its efforts to control inflation. Larry Summers believes the Fed will have to raise interest rates to 6% to put a roof on inflation’s trajectory. This means asset values, along with the general economy, are likely to plunge deeper, defying whatever optimism is left in the markets.
- The Fed may have to hike interest rates above 6% to curb stubborn inflation, Larry Summers said.
- The US economy seems to be shrugging off the rate increases so far, the former Treasury chief said.
- Summers warned that rising inflation expectations could lead to more, intractable price increases.
Unrelenting inflation could force the Federal Reserve to hike interest rates to north of 6%, the highest level in more than two decades, Larry Summers has warned.
The US central bank has rapidly raised rates from virtually zero in March to a range of 3.75% to 4% today, in a bid to cool the economy and bring down inflation from near 40-year highs.
Yet prices rose an annualized 8% in September — not far off their peak pace of 9.1% in June — and there's little sign of demand weakening or the labor market softening.
"The good news is the economy is looking robust," Summers said in a recent Bloomberg interview. "The bad news is there's not much evidence of inflation restraint yet."
Summers is a Harvard economics professor who previously served as Treasury secretary and the director of the National Economic Council. He suggested the economy might be more resilient to rate increases than expected, which could heap pressure on the Fed to hike further.
"It would not be surprise me if the terminal rate reached 6% or more," he said. The Fed last targeted an interest rate that high in 2001.
Summers also flagged a worrying increase in inflation expectations, which can spur workers to demand higher wages, and businesses to raise prices in anticipation of rising costs. Those behaviors can kickstart a wage-price spiral, making inflation a self-fulfilling prophecy.
"That's got to be a source of concern for them as well," Summers said about the Fed.
Meanwhile, he dismissed the idea that supply pressures, such as Russia's war with Ukraine or China's ongoing COVID-19 lockdowns, are behind the current bout of inflation.
"The people who talk about supply shocks, it's really just the last readout of team transitory," he said, referring to commentators who downplayed the inflation threat, saying it would fade once pandemic disruptions ended.
Summers has been one of the most prominent inflation hawks this year. He predicted in October that rates would likely peak above 5%, and warned hiking to that level would likely cause a recession and increase unemployment from under 4% to over 6%.
The veteran economist also cautioned in September that if the Fed doesn't crush inflation now, it might have to raise rates even higher down the line. Delaying would increase the risk of stagflation, and could be devastating for the global economy, he added.
Originally published on Markets Insider.
