Senate Democrats were careening toward a pivotal vote this August—one that could either resuscitate President Biden’s domestic agenda, or pull the plug on it. They wanted to pass the Inflation Reduction Act, a huge bill that would fund dramatic green energy investments and other domestic spending. The Dems needed to flip one senator to squeeze the legislation through the evenly divided chamber—that of their own colleague, Joe Manchin (D-W.Va.), who wanted assurances that any new spending bill wouldn’t be inflationary.
The Dems called in the heavy artillery—but they didn’t turn to a cabinet member, or a big-name lobbyist, or any current political headliner. They called on Larry Summers, the rumpled, cerebral Harvard economics professor and former Treasury secretary who hasn’t held a formal role in government since 2010. Sen. Mark Warner (D-Va.) recalled the frenetic home stretch in a press report: “I was walking the tunnels back to the Hart Building and saying to Larry, who was at some conference in Brazil at the time, ‘You gotta call Joe Manchin, and you gotta do it right now and convince him this is all cool.’”
A few weeks later, visiting with Fortune in his living room in tony Brookline, Summers confirms it: He placed the call. (The bill passed, of course, with Manchin’s vote.) Summers won’t go into specifics, but says, “I was quite involved in the politics in the late stages.” He adds: “I had credibility to say that [this bill] would not be inflationary. Several senators encouraged me to deploy that credibility, and I did.”
That credibility is the reason we’re talking in his parlor on a late summer day. Larry Summers has never been one to shy away from bold predictions, and recently he has stood out for one particular pronouncement. Summers—Treasury secretary under Bill Clinton, and chief economic adviser to Barack Obama—strenuously warned that the proposed $1.9 trillion American Rescue Plan, following already gigantic COVID relief spending and loose monetary policy, could “set off inflationary pressures … unseen for a generation.” He’s agreed to meet with us to discuss how the economy got into its current shaky state—and how we might get out of it. He is, to say the least, not very upbeat. “If we’re going to bring down inflation, you likely need a policy more restrictive than the policy that’s contemplated by the markets or the Fed,” he warns. “The Fed continues to be excessively optimistic.”
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Today, the noted economist commutes from Brookline to Harvard, where he holds the highest faculty rank, as university professor. When we met, he’d just returned from his summer house in Cape Cod; the next day, he would teach more than 400 students, at two political economics lectures and an advanced seminar. His yellow, columned three-story house, in a hilly neighborhood shaded by half-century-old sycamores, dates from 1901—he’s lived here since leaving the Harvard presidency in 2006. Oriental rugs cover the oak floors, and the shelves feature a number of trophies from his time in government—including a handwritten record of the Senate roll call from 1999 that confirmed him as Treasury secretary by a vote of 97 to two.
The passage of the Inflation Reduction Act gave Biden a huge win. But it was a win for Summers, too, who has risen over the decades from a brilliant economist (if prone to foot-in-mouth moments) to an éminence grise in the economic and political realms. The bill eschewed the COVID-style stimulus checks Summers railed against in favor of longer-term investments in green energy and a provision that allows Medicare to negotiate prescription drug costs, both aimed at lowering inflation. With nods toward opening up public lands and waters to drilling and fracking, it also solidified Summers’ status as a rare public figure in 2022 who is able to build bridges between opposing camps. On the flip side, this meet-in-the-middle approach manages to please neither progressives who want more spending nor conservatives who want less.
Still, as inflation remains worryingly high—clocking in at 8.3% in the latest August reading—a growing number of people in both camps now share Summers’ view that things are not, exactly, cool. For Summers, the greatest worry is that the Fed won’t have the resolve to raise rates high enough, and that the eventual cure will be far more costly than shouldering what could be a shorter, shallower downturn in the months ahead.
Back in Brookline, Summers—wearing gray slacks, a blue blazer and loafers sans visible socks—cracks open a can of Coke Original and starts talking.
How inflation spiraled out of control
Summers never bought the “transitory” argument, that inflation was a passing phenomenon caused by supply-chain bottlenecks and COVID-related shutdowns.
For Summers, the chief source of today’s heavy inflation is over-the-top demand caused by too much money chasing too few goods. So to throttle a runaway consumer price index, the Fed must keep tightening monetary policy to the point where demand falls—sharply. Just how far does Summers think the Fed needs to go?
Getting to the answers is a primer in Summers’ view that the heart of economics is arithmetic. He reckons that “underlying inflation,” excluding food and energy, is running at 4% to 4.5%, pretty close to the PCEPI (personal consumption expenditure price index) numbers that guide the Fed. (The PCEPI is calculated by the Bureau of Economic Analysis and widely used by the federal government, including to adjust Social Security payments.) In the Summers playbook, taming inflation requires a “real,” Fed funds rate that’s 1.0% to 1.5% higher than the pace of bedrock inflation.
By his reckoning, the right number is 5.0% to 5.5%. That’s far above the current Fed funds benchmark which is at a midpoint of 3.1%. Of course, the markets and most observers expect the Fed to go big again at the next several meetings. But the Fed funds futures markets, and the members of the Open Market Committee in their most recent poll, expect the number to max out at 4.6% next year. So Summers is calling for much higher Fed funds rate, and tighter policies, than investors or the Fed itself are anticipating.
Rising rates are already pummeling the giant industry most influenced by their fluctuations: housing. According to Ed Pinto, director of the American Enterprise Institute’s Housing Center, at 5% or 5.5%, “it’s likely that by the time we’d get to that number, the economy would already be in recession.” 30-year mortgage rates clocked in at 6.4% on Sept. 20—a collossal jump from just a year ago, and one that has already pushed home sales volumes one-third below 2021 numbers to where they stood in 2015. Pinto projects that by a year from now, the campaign of rates hikes will have pushed home values down an average of 8-10% across the board.
Wrestling inflation to near the Fed’s 2% target, Summers reckons, means crushing overblown demand. But fast-rising incomes are blunting the Fed’s campaign to fight inflation. Personal incomes are growing at over 5%, driven by a jobless rate in the mid-3% range that’s the lowest since the late 1960s. Inflationary pressures will only ease when Americans are feeling the pinch, when they’re spending a lot less money. Summers believes that economic reality dictates that will only happen when joblessness rises, so that more workers are available for each open job. Creating slack in the super-cramped labor market would curb the steep rise in wages.
“We’re seeing two vacancies for every employed person,” says Summers. “That number and the unemployment rate are at extraordinary levels. I’m not sure you’re restraining inflation until you get the unemployment rate close to 5%, and to significantly restrain inflation you’re likely to need unemployment for some period at 6%. I’d like nothing better than to be wrong in that calculation.” Job destruction is the last thing Summers wants to see. But he thinks that a tough campaign to contain the outbreak that costs jobs in the short run will ensure a much stronger job market in the future than the catastrophic choice of allowing inflation to keep bubbling.
Summers puts the chance of a recession at 75%. “History teaches us that soft landings represent the triumph of hope over experience,” he says. “There are no examples when inflation was above 4% and unemployment was below 4% that the economy achieved a soft landing. We are unlikely to achieve a reduction of inflation to something like the Fed’s target without a significant slowing of the economy.”
How long will it take for the Fed to push inflation back to the 2% goal, providing the central bank maintains the resolute stance Summers recommends? Here, the former Treasury secretary punctures the idea widespread on Wall Street that the central bank can quickly corral inflation, then start easing again in the not-too-distant future. “I suspect [it will take] several years,” he says. “It all depends on what happens in the real economy. If unemployment spikes to 6% or 7%, it will happen more quickly than if it stays at 5% or 5.5%. But the view that the Fed will be in a position to start easing in the middle of next year, and that that is consistent with the path to get us back to 2% inflation, really seems to me quite unlikely.”
Billionaires, biofuels, and the next pandemic
Of course inflation is hardly the only thing on Summers’ mind these days. During our interview in Brookline he was brimming with so many ideas that he wanted to keep talking during a picture-taking session in his top-floor study, a kind of book-lined, paneled aerie overlooking the rolling hills and cupolas of the surrounding suburb. I couldn’t leave without asking the great sage what he thought of today’s stock prices. “In general, it seems that the stock market is not pricing in the kind of decline in profits that would be associated with a meaningful recession, and therefore has looked rich to me,” he noted. “I hold any opinion on the level of the stock market very tentatively.” And he cited Jack Meyer, the legendary investor who headed Harvard’s endowment, “who, when asked the secret of his success, said that he never listened to a member of the economics department.”
Broadly speaking he thinks it’s crucial for America to keep the freewheeling entrepreneurial culture that spawns so many mega-billionaires because they’re also mega-job-creators. But he also believes they’re under-taxed: “If we had more people like Jeff Bezos and Bill Gates and Steve Jobs who built spectacular enterprises and made inordinate fortunes … that would be good for America.” But he also favors “a whole set of tax changes that would make them pay more and complicate any efforts to form intergenerational dynasties. The ease with which the wealthy can pass on their wealth to their heirs is an affront to the American ideal of equal opportunity.”
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He also supports more fracking and adding pipelines to replace the dangerous shipping of oil and gas on trucks: “What is most important is accelerating approvals for transmission and of both fuels and electricity. Reflex opposition to anything involving hydrocarbons in the environmental community is counterproductive, not only to the economy but to their own objectives.”
This plays into his nuanced view about when and how much governments should intervene in capitalism: “I’ve always believed the best generals are the ones that are most troubled by war and most skeptical about the military and violence as a tool. They’re reluctant warriors, but willing to fight if necessary.”
He adds: “For too long, we’ve had a sterile debate between those who ideologically oppose any policies that distort the perfectly free market and the Curtis LeMays of industrial policy who rush to seize on any argument for the government to take a role in the production of goods and services. What we need is a reluctant warrior approach on policies that promote specific industries and policies.”
Summers is furthermore championing a kind of federal Marshall Plan for countering the next pandemic, which he sees arriving within 10 to 15 years: “The pandemic risk is on the same order of magnitude as climate risk, but it’s not getting nearly the level of attention that it should,” he told me. “For pittances of tens of billions of dollars, relative to the tens of trillions that COVID has cost, we could be in a better position to act next time.” Summers wants a federal program that pays vaccine makers to build plants prepared for an outbreak that could sit idle for years; supports “scientific capacity to make vaccines quickly”; amasses big stockpiles of masks, syringes, and other equipment; and develops an infrastructure for screening.
As for his hobbies, Summers says he’s a frequent golfer at the Country Club in Brookline. Though he sports a 19 handicap, he quips: “The only aspect of the golf game I’m good at is doing a probabilistic analysis of whether it’s better to shoot over the creek or around the creek. Unfortunately, I’m not very good at swinging a golf club, which is a rather more important skill.” As for tennis, hours spent pounding balls against a backboard as a kid forged the reliable baseline game that he marshals at the famed Longwood Cricket Club. “On a physique and age-adjusted basis, I’m actually a very good tennis player, based on those reliable groundstrokes,” he declares. “On an absolute age-adjusted basis, I’m not bad.”
And of course, there’s one hobby that no economist can fully give up: worrying about the future. Summers frets that the legacy from the trillions in COVID relief spending he was so foresighted in criticizing, “may limit the resources available for the public investment needed for fighting secular stagnation. We’re like a family that borrowed a lot for its vacation rather than to fix its roof or expand its house. We have our debt and only memories of the party we had.” The aftermath of all that recklessness is the big inflation that Summers presciently saw coming. Now he’s making another contrarian call we should all heed on the sacrifices needed to fix it.