Former Treasury Secretary Larry Summers recently applauded the Federal Reserve for their stance on unemployment and inflation during an appearance on Bloomberg’s Wall Street Week. He stated that the Fed has come to realize that an increase in unemployment is necessary to control inflation; However, the location of his appearance— a beach surrounded by palm trees, has been criticized for its contrast with the harsh reality of the policy he was discussing.
According to Summers, who is now a Harvard University professor and a paid Bloomberg News contributor, America’s unemployment rate needs to substantially increase in order to contain inflation— and the Fed’s hawkish approach on interest rates is on the path to do just that.
Summers, along with Fed members, believe that when borrowing costs rise, companies start laying off employees because the cost of borrowing becomes too expensive. This in turn leads to less spending power and reduced competition for goods. The idea is that with more unemployment, employees will accept lower salaries which in turn lowers the cost of goods.
By raising interest rates and making the cost of borrowing capital more costly, the Fed believes it will prevent a wage price spiral, whereby workers demand higher wages, forcing companies to add the increased costs onto consumers. The Fed believes that when unemployment is high, consumers demand less goods; however, most people are currently complaining about price increases for essential items, such as food and rent.
Moreover, the individuals most susceptible to layoffs are lower-wage earners, and it is unlikely that controlling grocery prices by making poor people demand less food will have any impact. This policy would also put added pressure on workers who have already experienced years of declining real wages, as well as on food banks which are already stretched thin due to the pandemic.
Information for this briefing was found via Bloomberg and the sources mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.