The Fed needs to hike rates to at least 5% or risk bringing stagflation and recession on the US economy, Larry Summers says

Federal Reserve Chair Jerome Powell testifies before a Senate Banking Committee hearingKent Nishimura / Los Angeles Times via Getty Images

  • The Federal Reserve needs to hike interest rates to 5% to avoid stagflation and recession, Larry Summers says.

  • The Fed “needs to take far stronger action to support price stability than appears likely,” Summers wrote in an op-ed.

  • The Fed needs to abandon its thinking on inflation, according to Summers.

As the Federal Reserve prepares to kick off a series of interest rate hikes Wednesday, its current policy roadmap will steer the US into stagflation and a major recession, according to former US Secretary of the Treasury, Larry Summers.

In an op-ed for the Washington Post, Summers described Fed Chair Jerome Powell’s optimism around taming inflation as wishful thinking.

“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,” wrote Summers.

While the Federal Reserve must prioritize price stability to sustain employment, Summers said the reality is that real short-term interest rates will have to hit 5% to stave off a recession — and markets currently think this number is “unimaginable.”

Summers, who is currently the President Emeritus of Harvard University and previously led President Barack Obama’s National Economic Council, noted that a recession often follows conditions of high inflation and low unemployment.

The Fed has drawn criticism over the last year for its characterization of inflation as “transitory.” The central bank backed down from that call as prices surged close to 40-year highs. Economists have slammed the Fed for not pivoting away early enough from its pandemic-era easy money policies.

As recently as two weeks ago, Summers points out, the central bank was still snapping up mortgage-backed securities despite skyrocketing home prices.

Summers added that, during the pandemic, the Fed adopted a new approach of allowing high inflation to stick around for an extended stretch of time — “this new framework should be abandoned,” wrote Summers.

“I hope the Fed will make clear that inflation reduction is its principle objective, and that it will wind down efforts to promote worthy but non-monetary goals such as social justice and environmental protection,” wrote Summers. “This implies committing to doing whatever is necessary with interest rates to bring down inflation, including movements of more than a quarter-point at some meetings and a rapid reduction of its balance sheet.”

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