High unemployment may be the only way to stop inflation

Former Treasury Secretary Larry Summers said the U.S. needs a significant rise in unemployment to stave off more inflation

To stop inflation, former Treasury Secretary Larry Summers says high unemployment for an extended time period may be the only way to curb rising inflation.

Summers, whose comments were made at a speech in London and reported by Bloomberg, said the U.S. needs five years of unemployment above 5% to contain inflation, or two years of 7.5% unemployment, five years of 6% unemployment, or one year of 10% unemployment.

Unemployment is currently 3.6% according to the Bureau of Labor Statistics.

Typically, when inflation is high, unemployment is low, and Summers argument is that higher unemployment means less discretionary income going into the economy, thus lowering demand and reducing prices.

Current Treasury Secretary Janet Yellen says that overall consumer spending is strong, but that spending patterns are changing due to rising food and energy prices. She says that household savings that grew during the pandemic will help sustain spending.

The national saving rate is now around 6%, below pre-pandemic levels, after hitting 16.6% in 2020 and 12.7% in 2021.

Yellen told national news shows over the weekend that she expects the economy to slow after a period of very rapid growth, but to not hit recessionary levels.

If unemployment and inflation lose their inverse relationship — creating a period of high unemployment with high inflation — this creates what is known as stagflation. The last time this happened was in 1973. The fix was for the Fed to raise the federal funds rate to more than 20%, creating record unemployment rates, but also bringing inflation back to acceptable levels.

The Fed said last week that it would do whatever it takes to get prices under control, saying its commitment to reining inflation is “unconditional,” and added that stability is necessary to support a strong labor market.

The central bank increased interest rates 0.75% last week, the biggest increase since 1994 and indicated another large increase may happen in July. The Fed also downgraded its economic outlook, stating that the economy is now seen to have 1.7% growth with unemployment rising to 3.7% by the end of the year and rising to 4.1% through 2024.