Ukraine War, Excess Stimulus Raise 1970s Stagflation Risk, Summers Says

(Bloomberg) -- Former Treasury Secretary Lawrence Summers said that the war in Ukraine and the legacy of Washington pumping too much stimulus last year means an increasing danger of stagflation for the U.S. economy.

“We're now facing real risks of a 1970s-type scenario,” Summers told Bloomberg Television's “Wall Street Week” with David Westin on Friday. “Not quite as high levels of inflation as we saw in the 1970s, but the same kind of broad phenomena of stagflation.”

The risks reflect the surge in oil and other commodity prices triggered by Russia's invasion of Ukraine, but also the “excessive stimulation of the economy during 2021,” Summers said. He has repeatedly described the $1.9 trillion pandemic-relief bill of March 2021 as being too big for the economy to handle without stoking prices.

The U.S. enjoyed a strong recovery coming out of recession in 1975, before supply shocks and overheating led to a “very serious inflation situation,” Summers said. Prices were ultimately tamed by unprecedented monetary tightening by then-Federal Reserve Chair Paul Volcker in the late 1970s and early 1980s.

Fed policy makers now will have to make “difficult choices,” with the risk weighted toward doing “too little” to combat inflation rather than too much, said Summers, a paid contributor to Bloomberg Televsion and a Harvard University professor.

“Monetary policy is an effective tool but it may not be an effective tool without engineering a slowdown,” Summers said.

It's possible that commodity prices will ease and supply bottlenecks will clear -- dissipating price pressures in the economy and avoiding any ratcheting up in inflation expectations, he said. The situation could “solve itself with modest action by the Fed and the passage of time.”

“That kind of soft landing is certainly possible -- it's not what I expect,” Summers said.

There's a real possibility that “without a significant slowdown in the U.S. economy, we're likely to have inflation be unanchored two years from now,” he said.

The key variable to watch is the job market, he added. With record levels of quits and job openings, current conditions in the U.S. labor market would historically have corresponded to a 2% unemployment rate, Summers estimated. He spoke shortly after the February jobs report showed a stronger-than-expected gain in payrolls along with a drop in the jobless rate to 3.8%.

While that report also showed that average hourly earnings didn't increase last month from January, Summers predicted more wage inflation ahead.

Summers reiterated his support for President Joe Biden's proposals to make social investments, including expanded federal help for childcare. But he urged that any spending doesn't add to fiscal deficits over the next several years. He also said policy makers should be prepared for rising defense spending needs in coming years.

Biden began a transition, in his State of the Union speech Tuesday night, toward making the preservation of democracy in the face of authoritarian threats in the world his defining mission, Summers said.

But there is “a ways to go,” he said.