Former Obama economic adviser predicts stagflation, 'major' recession if Fed continues current policies

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Former Obama economic adviser Larry Summers offered a grim outlook for the U.S. economy this week, predicting stagflation and a "major" recession if the Federal Reserve continues on its current policy trajectory. 

In a Tuesday op-ed for The Washington Post, Summers argued the Fed was operating within an "inappropriate and dangerous framework" when it came to addressing the inflation crisis and needed to take stronger action to address it lest the economy face far greater hurdles over the next few years.

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"I believe the Fed has not internalized the magnitude of its errors over the past year, is operating with an inappropriate and dangerous framework, and needs to take far stronger action to support price stability than appears likely," Summers wrote.

"The Fed’s current policy trajectory is likely to lead to stagflation, with average unemployment and inflation both averaging over 5 percent over the next few years — and ultimately to a major recession," he added.

Summers argued, citing research he conducted with a colleague at Harvard University, that overheating conditions of high inflation and low unemployment, both currently facing the U.S., are usually followed by a recession. 

He noted various errors he felt the Fed had made over the past year when addressing inflation, including predicting it would remain in the 2 percent range and be transitory, and continuing to buy mortgage-backed securities despite house prices increasing more than 20 percent. 

"No explanation has been offered for these rather momentous errors. Nor is there any suggestion that the Fed forecasting procedures or the personnel that produced them will change," Summers wrote. "Indeed, the most important change in the March Monetary Policy Report to Congress was in the wrong direction — the removal of the discussion of the various monetary policy rules that had suggested policy was dangerously loose."

"So there is little basis for confidence in the Fed’s assessment of inflation risks," he added.

NEW YORK, NY - MAY 24:  Former Treasury Secretary and White House Economic Advisor Larry Summers is interviewed by FOX News' Maria Bartiromo at FOX Studios on May 24, 2017 in New York City.  (Photo by Robin Marchant/Getty Images)

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Summers noted that the country was now facing new inflationary pressures in the form of high energy prices, the ongoing war in Ukraine, and potential supply-chain disruptions due to coronavirus lockdowns in China. 

"It would not be surprising if these factors added three percentage points to inflation in 2022. And with price increases outstripping wage increases, a wage-price spiral is a major risk," he wrote. 

Summers called on the Fed to return to its framework of addressing inflation before it materializes and emphasized that price stability is "essential for sustained maximum employment."

He argued that substantial increases in interest rates and temporary increases in unemployment were the only reliable ways to make progress against inflation increases.  

"Central to success in fighting inflation is establishing credibility that a new paradigm is in place. Recognizing failed strategies, and then abandoning them, is the first step," Summers wrote. 

WASHINGTON - JANUARY 22:  The Federal Reserve building is seen January 22, 2008 in Washington, D.C. (Photo by Chip Somodevilla/Getty Images) (Photo by Chip Somodevilla/Getty Images)

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"I hope the Fed will make clear that inflation reduction is its principal objective, and that it will wind down efforts to promote worthy but nonmonetary goals such as social justice and environmental protection," he added. 

"To avoid stagflation and the associated loss of public confidence in our country now, the Fed has to do more than merely to adjust its policy dials — it will have to head in a dramatically different direction," he wrote.