Trump should heed Larry Summers’ inflation warning

The article below was published by The Times (UK) newspaper on November 21, 2024. Given this week’s increase in core inflation, it seems pertinent again.

Back in February 2021, Larry Summers issued an unusually stark warning to President Biden. The scale of America’s fiscal and monetary stimulus, Bill Clinton’s former treasury secretary explained, could unleash inflation “of a kind we have not seen in a generation”. Democrats in Washington brushed him off, dismissing fears about “running the economy hot”. Their priority was to avoid what they perceived as the key mistake after the financial crisis: too little stimulus, rather than too much.

Sixteen months later, inflation hit its highest level since 1981. Food prices shot up 21 per cent in three years, and borrowing costs for homes, cars and credit cards climbed sharply as interest rates rose. Despite White House attempts to pin the blame on Vladimir Putin and greedy corporations, voters didn’t buy the excuses. In exit polls from this month’s US presidential election, inflation topped the list of reasons why the public rejected vice-president Kamala Harris, Biden’s chosen successor.

Summers isn’t an oracle; no economist is. He hedged his 2021 warning and later overestimated how much collateral damage in lost output and unemployment would be needed to bring inflation back down. Yet his message today is unambiguous: implementing Donald Trump’s full campaign agenda would risk unleashing an even bigger inflationary shock than Washington’s recent fiasco. Exaggeration or not, it’s a warning that Trump should take seriously.

Markets reacted to Trump’s win with a surge in stock prices and an appreciating dollar, fuelled by expectations of corporate tax cuts, tariffs and high deficits. Yet the modest rise in inflation expectations was just as telling, reflected in widening yield spreads between Treasury Inflation-Protected Securities (TIPS) and regular Treasury bonds. Core inflation at 2.6 per cent remains stubbornly above the Fed’s 2 per cent target, while wages and spending are still growing faster than historically consistent with hitting it. Trump’s full plans could thus pour petrol on to inflation’s smouldering embers.

Last week at Harvard Kennedy School, Summers spotlighted the twin threats of this in Trump’s agenda. On the demand side, a Republican sweep of Congress and the presidency could hand Trump the green light for massive tax cuts, ballooning a budget deficit already teetering at nearly 7 per cent of GDP.

Normally, the Fed would counterbalance such fiscal excess with tighter monetary policy. Yet Trump spent his first term publicly pressuring the Fed to slash rates and floated more presidential control over monetary policy during the campaign. While the Federal Reserve chairman Jerome Powell recently said “no” when asked whether he’d quit if Trump wanted him to, any whiff of compromising the Fed’s independence or leaning on it to monetise federal debt could rattle markets and send inflation expectations soaring.

On the supply side, Trump’s protectionist agenda would choke the economy’s productive capacity just as his macroeconomic policies stoke demand. His plans include universal tariffs of up to 20 per cent, a 60 per cent levy on Chinese imports and mass deportations of undocumented workers — who, crucially, comprise nearly half of America’s agricultural workforce.

Food and import prices would spike but the fallout wouldn’t stop there. Tariffs on production inputs, retaliatory foreign levies and reduced competition would throttle real output, triggering a sharp, one-off jump in the price level. Would the Fed really weaken demand sufficiently to fully counteract this price shock? Unlikely. With its dual mandate to protect both employment and price stability, it would be wary of any recession risk.

Trump has so far brushed off these fears, effectively saying, “I borrowed for tax cuts and slapped on tariffs before, but inflation stayed low.” Yet today’s macroeconomic backdrop is different. Inflation remains slightly elevated, and his promises far outstrip any first-term ambitions. Summers is right: the threat of inflation’s return is real. If Trump doesn’t rein in his proposed borrowing and protectionism, he risks alienating a public that loathes rising prices — and dooming his presidency from the outset.