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Inflation is a ‘consequence of the overheating of the economy’: Larry Summers

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Former Treasury Secretary Larry Summers sits down with Yahoo Finance's Jennifer Schonberger to assess the Inflation Reduction Act's impact on taxes and employment, as well as the Fed's inflation-fighting strategy.

Video Transcript

- Five former Treasury secretaries signing on to support the Democrats' inflation reduction legislation, saying, among other things, that it does fight inflation despite some recent studies. Let's bring in Jennifer Schonberger, who spoke with former Treasury Secretary Larry Summers. Jen.

JENNIFER SCHONBERGER: Hi, Seana. That's right. Former Treasury secretaries Geithner, Lew, Paulson, Summers, and Rubin all endorsing that legislation, saying in a statement, quote, "taxes due or paid will not increase for any family making less than $400,000 a year and that extra taxes levied on corporations do not reflect increases on the corporate tax rate, but rather the reclaiming of revenue lost to tax avoidance and provisions benefiting the most affluent."

As you mentioned, former Treasury Secretary and President Emeritus of Harvard University Larry Summers joined me to discuss this as well as his outlook for the economy and inflation. I asked him how imposing a minimum corporate tax rate would impact job creation and business investment at a time when the economy is slowing. Take a listen.

LARRY SUMMERS: I don't think the effects are likely to be harmful. I think that the total effects of this bill could very likely be positive. The stimulus to renewable investment in particular that's given by the tax credit provisions is likely to do far more to stimulate investment than closing various loopholes, which in some cases probably encourage financial manipulation rather than real productive investments.

I don't think there's any reason at all to think that asking corporations that report themselves as profitable every year to pay something in taxes at a minimum rate of 15% is likely to be harmful. And in fact, by expanding the taxation of their global income relative to their domestic income, I actually think this could encourage jobs to be brought home.

JENNIFER SCHONBERGER: Republicans have argued that the bill would break President Biden's pledge to not raise taxes on those earning $400,000 or less based on the Joint Committee on Taxation's analysis that higher taxes paid by corporations would indirectly raise the effective tax burden on those with incomes of $200,000 or less. Your rebuttal to that.

LARRY SUMMERS: I don't think that's a credible argument. What the taxes are placed on corporations that are placed only on profitable corporations. Disproportionately they're going to fall on corporations who are making investments abroad. That's going to work out on balance favorably for the whole economy. There's no sense in which this is a tax placed on any family with income below $400,000.

JENNIFER SCHONBERGER: What is your outlook for inflation from here? And how does this bill tie in with that?

LARRY SUMMERS: Jennifer, I think we've got real inflation problems in the country. I don't think they're going to go away quickly. I think they're a consequence of the overheating of the economy that took place last year, along with adverse supply shocks. And that's just something we're going to have to work through and live with. I think we will do so in a better way if this bill passes. But this bill is certainly not sufficient to contain our inflation problem. And even with this bill, we're going to have inflation problems for quite some time to come. The important thing, though, is that this is doing a whole set of necessary things for our country while beginning the process of reducing inflation pressure.

JENNIFER SCHONBERGER: You just said you think inflation is going to be with us for a long time to come. And as just noted, the Fed has been pretty aggressive. Do you think they should sustain that aggressive stance? Fed Chair Powell said at his press conference that there's a prospect of perhaps tailoring the size of those rate hikes, or minimizing, I should say, the size of those rate hikes from 75 maybe to 50 basis points and there 25 basis points. Do you think the Fed needs to be more aggressive as we go through the latter half of this year?

LARRY SUMMERS: We'll have to see how the data unfolds. I'm not prepared to make a prescription for the September Fed meeting at this point. I do think there's an important lesson that we all learn at some point in our lives, which is when the doctor prescribes a set of antibiotics, you have to take the whole course through. And you're making a mistake and you're compromising your potential health if you stop taking the antibiotics the moment you feel better.

And I think there's some similar principle here with respect to the central bank that if inflation comes down a bit, if the economy looks like it's slowing, it will be tempting to stop raising interest rates. And, indeed, people in the market are expecting that interest rates will come down beginning in December or January. And I think that would be a serious error.

JENNIFER SCHONBERGER: Do you think that a recession is near or that we are in one, given what we've seen with the GDP numbers?

JENNIFER SCHONBERGER: I don't think we're in a recession. I think it's unlikely that it will be judged that in July of 2022 the American economy was in recession. I think given the difficulties associated with high inflation and bringing it down, the necessary monetary policy response, the odds that the economy will go into a recession within the next 18 months are quite serious and probably in the 3/4 range. And I think that if the economy gets into a situation where unemployment rises, unemployment is likely to rise quite substantially. And so I would expect sometime within the next two or three years that the unemployment rate would cross 6%.

JENNIFER SCHONBERGER: And then would that be the medicine that's really needed to get inflation back under control? Is a recession needed, essentially?

LARRY SUMMERS: I think we're unlikely-- as I've said many, many times, I think we are unlikely to restore inflation to target levels in scenarios that don't involve a recession at some point.

JENNIFER SCHONBERGER: And Summers also telling me in that interview that he thinks the administration should reverse former President Trump's tariffs on China and tariffs overall to help cool inflation as well as take some other actions. You can hear more and learn more about that on our website finance.yahoo.com. Guys.

- Great job, Jen. Excellent stuff--

JENNIFER SCHONBERGER: Thank you.

- --with Larry Summers. Well done. All right. Let's talk more about this with Yahoo Finance Editor in Chief Andy Serwer, who's here to give his take on that. Interesting. There's so much to really unpack there. But I want to go back to the beginning because he really re-emerged, Larry Summers, when he was challenging the Biden administration for their spending and, in fact, driving inflation up with that spending. And now he seems in favor of this massive spending bill because he thinks it's going to help drive down inflation. Are you surprised by that?

ANDY SERWER: Well, that's an interesting way to frame it, Dave. I mean, he is definitely taking a victory lap given that he predicted this run of inflation and now thinks actually the Fed is on track with these rate hikes. This bill is specifically tailored, as he talked about with Jen, to investments in the green economy, for instance, and renewables. So he would make that distinction, I'm sure.

- Yeah. It's probably mislabeled as the Inflation Reduction Act. It's a lot of other things.

ANDY SERWER: The names of these bills. I thought there was a couple interesting takeaways to my mind. First of all, he said 75% chance of recession, calling that out. Also, I love that metaphor about taking your medicine all the way through with your prescription. How many of us know that, like, oh, I want to stop taking these pills because I feel better with regard to rate hikes. And what Jennifer said at the end about Larry Summers favoring getting rid of tariffs on China is an interesting point. And I'd love to see bipartisan support there. That would be an interesting conversation.