Larry Summers warns of 1970s economic crisis if banks back down on interest rates

Former Treasury Secretary Larry Summers warned on Friday that backing down on interest rates as a means of controlling inflation could precipitate a 1970s-style economic crisis.

“I think to suppose that some kind of relenting on an inflation target will be a salvation would be a costly error that would ultimately have adverse efforts, as it did in a spectacular way during the 1970s, for real economies and working people everywhere,” Summers said at a World Economic Forum panel in Davos, Switzerland.

Many have drawn comparisons between the current economic situation and that of the '70s, when the global economy faced a combination of high inflation and slow growth known as stagflation.

Since the 1990s, the Federal Reserve, the European Central Bank and other central financial institutions have sought to prevent runaway inflation, setting a target inflation rate of 2 percent.

As inflation soared over the last year, reaching a 40-year U.S. high of 9.1 percent in June, the Federal Reserve and other central banks have raised interest rates in an effort to bring it back down to the 2 percent target.

The Federal Reserve has begun to slow its interest rate hikes in recent months as inflation has steadily declined. In December, the U.S. inflation rate dropped to 6.2 percent, down from 7.3 percent in November but still abnormally high.

Amid this reality, some have recently suggested that the Federal Reserve and other central banks revise their inflation targets upward slightly. However, Summers warned on Friday that this would be a “grave error.”

“I say that as someone who was negative on the idea that the United States should put in place a specific numerical target,” Summers added. “It seems to me, though, that … having reemphasized repeatedly the absolute commitment to the 2 percent inflation target, to then abandon the 2 percent inflation target would do very substantial damage to credibility.”

Summers also suggested that the rhetoric of “it’s not worth having a recession to reduce inflation” is mistaken. 

As the Federal Reserve has raised interest rates, some have warned of the potential for a recession. While interest rate hikes can help slow inflation, raising rates too quickly can also potentially tip the economy into a recession. 

“The counterfactual is not, ‘Can we have more inflation and not have a recession?’” Summers said. “The counterfactual is, ‘If we fail to deal with inflation, we are likely to have a larger and more serious recession at some subsequent point.’”