Sun. Dec 5th, 2021

Former US Treasury Secretary and Harvard economics professor Larry Summers is concerned that the US economy may overheat and see prices go out of control, drawing parallels to the late 1960s.

Such a sustained price eruption in the world’s largest economy would have contagious effects on inflation and interest rates in the rest of the world.

“The markets certainly still expect me to make a mistake,” Professor Summers told The Business.

“But my feeling is that the preponderance of risk is very much on the side of overheating.”

Inflation in the US is running at more than 5 per cent on an annual basis, while the labor market is plagued by growing labor shortages and bottlenecks in supply.

On top of that, an energy crack is already dramatically driving down the prices of natural gas, oil and coal.

“What has surprised me is how tight the labor market has become and how fast [it happened], how many bottlenecks on the supply side have returned and how fast inflation has accelerated, “said Professor Summers.

He said there was “a storm of inflation”.

Back to the future of inflation

Mr Summers said the price pressure he saw rising in the economy reminded him of the late 1960s, when inflation shot up sharply from below 2 per cent to more than 6 per cent, even before major supply constraints were apparent.

“We saw inflation move from having a handle in 1966 to having a six handle in 1969,” Professor Summers said.

“And we have a much bigger budget deficit today than we did then. We have a lot more in the way of bottlenecks in supply popping up much faster than we did back then.

The late 1960s preceded the OPEC oil embargo in the early 1970s (1973-74), when the oil-producing cartel cut off supplies, caused even greater price shocks and sent spiraling inflation on a collision course with central banks.

As a result, there was a period of so-called “stagflation”, in which economies stalled in recessions while prices continued to rise rapidly and central banks felt compelled to keep interest rates high.

Professor Summers said he was crossing his fingers that a more positive result prevailed and that the inflation recorded now was transient and began to ease, as the US economy cooled enough to avoid large interest rate hikes.

However, he said he was not convinced a “Goldilocks” scenario was likely, fearing it could require more rate hikes than most expected to cool an overheated US economy, despite very high debt levels for some sectors.

“I suppose, for various reasons, we have a less interest-sensitive economy than we once had,” he said.

“I think we’re looking at a pretty volatile economic environment.”

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