Unemployment must hit 6% for Fed to tame inflation

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Unemployment must hit 6% for Fed to tame inflation

Former Treasury Secretary Larry Summers said he still believes US unemployment will have to rise to 6% to properly address decades-high inflation – an increase that would mean layoffs for millions of Americans.

Summers, a frequent critic of the Federal Reserve’s handling of the economy, argued the central bank’s projection that the median unemployment rate will rise no higher than 4.4% through 2025 is likely inaccurate. The jobless rate was 3.7% through August.

“We are unlikely to achieve inflation stability without a recession of a magnitude that would take unemployment towards the 6% range,” Summers said in an interview with The Financial Times published Thursday.

Fed Chair Jerome Powell and other policymakers have acknowledged some job losses are inevitable as interest rates rise. The Fed has enacted three consecutive three-quarter point hikes to its benchmark rate, with further sharp increases telegraphed before the year ends.

Larry Summers
Larry Summers is a former Treasury Secretary.
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The Fed’s current projection for unemployment would mean roughly 1.2 million job losses, assuming no change in the size of the labor force, according to CNN.

A team of researchers that included two economists from the International Monetary Fund projected that unemployment of 7.5% would mean about 6 million job losses, Reuters reported.

Summers asserted the job losses, while hard to stomach for the labor market, are a necessary side effect of an effective fiscal policy that will limit long-term negative consequences for the US economy.

Fed Chair Jerome Powell
The Fed has hiked rates by three-quarters of a percentage point at three straight meetings.
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“The question is not some trade-off of inflation against unemployment,” Summers said. “The question is what policy path would minimize the total amount of unemployment distress over time.”

“Just as the patient who doesn’t complete his regimen of medicines does herself no favor, or the oncologist who prescribes too few courses of chemotherapy does their patient no favors, I believe the prospects for robust American and global growth will be greater if we do not allow inflation expectations to become fully entrenched,” he added.

Unemployment typically rises when the Fed hikes interest rates as it becomes more expensive for companies to service debt and borrow money. Corporations typically aim to slash their expenses when the economy slows – as seen by the wave of layoffs impacting the tech industry and other sectors.

Summers, who was a top official in the Clinton and Obama administrations, also questioned the Fed’s current road map for interest rate hikes.

The central bank currently projects the federal funds rate will hit 4.4% by the end of the year and gradually decline to 2.9% as inflation recedes back to its 2% target range.

“My suspicion, but it is only a suspicion, is that [the Fed] will have to raise rates ultimately a bit more than their ‘dot plot’ forecasts suggest, or the market is now anticipating,” Summers said. “My much stronger conviction is that there is still an underestimation of what the economic consequences of all of this will be.”

Last week, Summers warned that levels of risk in global markets are similar to levels seen in 2007 ahead of the Great Recession.

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