Larry Summers warns of ‘spectacular’ 1970s-style economic crisis if Fed blinks on inflation

The Federal Reserve and other central banks risk a 1970s-style economic crisis if they ease up on their efforts to tame inflation, ex-Treasury Secretary Larry Summers warned Friday.

Summers cautioned against proposals from some experts, including former International Monetary Fund chief economist Olivier Blanchard, who have argued that central banks should raise their target inflation rate above the 2% benchmark long held by the Fed and other institutions.

“To suppose that some kind of relenting on an inflation target will be a salvation would be a costly error, it would ultimately have adverse effect as it did in a spectacular way during the 1970s,” Summers said while speaking on a panel at the World Economic Forum in Davos, Switzerland, according to Bloomberg.

Inflation has cooled in recent months after its decades-high surge last year – a trend that has prompted anxious investors to call on the Fed to halt further interest rate hikes. Critics of the Fed’s approach argue that more increases could tip a slowing economy into a recession.

Summers said policymakers would risk hurting the credibility of central banks if they accept a higher base inflation rate solely out of fear of an economic recession.

“It would be a grave error for central banks to revise their inflation target upwards at this point,” Summers said. “Having failed to attain the 2% target and having re-emphasized repeatedly the commitment to 2%, to then abandon the target would do very substantial damage to credibility. If you can adjust once, you can adjust again.”

“The counter-factual is not ‘Can we have more inflation and no recession,’ it is ‘If we fail to deal with inflation, we are likely to have a more severe recession at some point,’” Summers added.

Fed Chair Jerome Powell has reiterated on several occasions that the central bank is committed to the 2% target. Inflation cooled to 6.5% in January, though high prices for staple grocery items and costly rent remain a source of constant pressure on American households.

Powell has also signaled the Fed is wary of backing off its fight against inflation too soon, citing past instances when doing so resulted in more long-term economic pain.

The market will be closely watching Fed officials in the coming days for any sign they will “blink” by easing or entirely pausing interest rate hikes.

The Fed will announce its next policy decision on Feb. 1 after the conclusion of a two-day meeting.