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WASHINGTON - History seems to have a way of placing current U.S. Treasury Secretary Janet Yellen and one of her predecessors, Lawrence Summers, on opposite sides of major policy battles. Right now, the two celebrated economists are facing off in an argument about whether government spending coupled with near-zero interest rates are creating the danger of unchecked inflation.
With inflation rising sharply over the past few months, Summers is seriously - and vocally - concerned about prices rising out of control, whereas Yellen has been supportive of the Federal Reserve's apparent belief that the extra stimulus is justified as a means of bringing the economy back toward full employment, and that inflationary pressures will be temporary.
The Federal Reserve last week made markets shudder by responding to a sharp rise in inflation by suggesting that it might raise interest rates slightly in 2023 and take other measures to tighten monetary policy somewhat sooner.
'Errors of thinking'
Summers, the one-time president of Harvard University known for a certain lack of diplomacy when describing those who disagree with him, offered a backhanded compliment to the Fed for its decision to, as he put it, begin facing up to "reality."
"I welcome the Fed's limited efforts to mark its views towards reality and a growing awareness that this overheating is likely to necessitate a monetary policy response," Summers said at the Qatar Economic Forum on Monday.
"The prevailing forecast at the Fed, in the White House, indeed in much of the consensus of professional economic forecasters in February was that we would have inflation just above 2%," Summers said. "This year, we've already had more inflation than that in the first five months of the year. That would suggest to me that people should not just modify their forecasts. But should think about what their errors of thinking were that led them to be so far off in their forecasts."
Echoes of 2013
While the situation is slightly different, it has echoes of the last time Yellen and Summers found their names in headlines at the same time.
In 2013, both were on then-President Barack Obama's short list to replace Ben Bernanke as the next chair of the Federal Reserve Board, the U.S. central bank. As vice chair of the Fed, Yellen seemed like a natural pick to many, but Summers had served as director of the National Economic Council during the first two years of Obama's first term, and was seen as a contender, too.
Facing a barrage of criticism from the left wing of the Democratic Party, which saw him as too close to Wall Street and believed Yellen would be more likely to pursue the goal of full employment rather than simply managing inflation, Summers withdrew from the running. He was forced to sit on the sidelines as the Obama administration continued to drag the U.S. economy out of the morass of the Great Recession.
Unsparing criticism
Now, more than two decades since Summers ran the Treasury Department, Yellen is occupying that office, and the two find themselves again on opposite sides of a debate over how the U.S. should be managing the recovery from a recession -- this one brought on by the coronavirus pandemic.
During the first six months of the Biden administration, Yellen at Treasury and her successor at the Fed, Jerome Powell, have overseen an administration policy that calls for trillions of dollars in extra government spending on both financial support for Americans and investment in infrastructure and social spending.
Summers has been unsparing in his criticism of injecting huge amounts of money into the economy, out of concern that it will cause inflation to spike. Once again, he has drawn the wrath of liberal Democrats who are clamoring for more government spending,
'More...grave risks than I can remember'
"These are the least responsible fiscal macroeconomic policies we have had for the last 40 years," Summers said in March, after a major stimulus package passed.
He added, "There are more risks at this moment that macroeconomic policy will cause grave risks than I can remember."
For her part, Yellen has charted a course for the Biden administration that deeply discounts Summers' concerns.
"In the United States, there have been factors that are transitory that in past years have raised inflation without affecting the underlying inflation rate and factors that have lowered it that have also been transitory," she said in remarks earlier this month. "And I genuinely believe that policy should look through transitory factors."
Change in thinking
In the past decade, there has been a pronounced shift in the way U.S. policymakers approach the question of inflation.
The Fed and other central banks around the world have moved from a time when central bank policymakers were deliberately opaque about their plans -- "If you understood what I said, I must have misspoken," former Fed chair Alan Greenspan once famously told a senator -- to being extremely explicit about what they plan to do.
The Fed now believes in "average inflation targeting," which means that it will use the tools at its disposal to try to make inflation average about 2% -- meaning that it will allow the rate to be higher sometimes, and lower at others, but always moving around the 2% axis.
Managing expectations
One of the reasons for being specific about an inflation target is that price increases have a psychological factor. If people expect prices to keep going up sharply, they will buy things now rather than putting them off, creating a self-fulfilling cycle of higher and higher prices.
That's why policymakers frequently talk about "inflation expectations." Part of the bet they are making, and one that has paid off for years, is that by creating a strong presumption that inflation will be kept in check, it will make inflation expectations "sticky." That means that it will take more than a brief run of higher- than- average inflation to convince consumers that an upward price spiral is just around the corner.
When it comes to managing inflation by managing expectations, "Larry didn't really get the memo," said Ken Kuttner, professor of economics at Williams College, referring to Summers.
The former treasury secretary, he said, is simply not as sanguine about the central bank's ability to gently change the course of inflation once prices start rising.
Holding the course
In testimony prepared for delivery to the House Select Subcommittee on the Coronavirus Crisis Tuesday morning, Federal Reserve Board Chair Powell conceded that "inflation has increased notably in recent months" but gave no suggestion that he, Yellen, and others managing the recovery for the Biden administration, are planning a major policy change in the near future.
Part of the change in inflation is explained by the calendar, he said, as the low-inflation months early in the pandemic are taken out of the calculation of the annual rate.
Other factors include those that he and others at the Fed have been pointing to all along, including "the rebound in spending as the economy continues to reopen; and the exacerbating factor of supply bottlenecks, which have limited how quickly production in some sectors can respond in the near term."
Powell's conclusion remains essentially unchanged, he indicated in remarks echoing Yellen's assessment. "As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal," he said.