Lawrence Summers is almost certainly right here, unfortunately. Though it’s probably not necessary to say unemployment “will have to rise”. It’s going to rise, most likely, all by itself:
Former Treasury Secretary Lawrence Summers says the only way to tame the red-hot 8.6% inflation rate in the U.S. is for unemployment to rise above 5% for a protracted period of time.
“We need five years of unemployment above 5% to contain inflation—in other words, we need two years of 7.5% unemployment, or five years of 6% unemployment, or one year of 10% unemployment,” Summers said in a speech in London Monday
Couple of things to note here as technical matters: The US measures unemployment differently to Ireland. Over there, it’s the percentage of people actively seeking work who can’t find it. In Ireland, those who’ve been on the dole for ages and aren’t actively looking are counted as unemployed, meaning our figures are always a little higher than theirs even if the situations are identical. So when he talks about 5% unemployment in the US, consider that might mean 8-10% in Ireland to achieve the same result.
Second, this isn’t some kind of cruel and heartless statement prescribing sacking people as a cure for inflation. The simple fact is that inflation causes joblessness by itself: As prices rise, and wages can’t keep up, demand falls. That means companies earn less, which means the lay off workers. And those workers in turn demand less, and so on, and so on, until you’re in a full blown recession. Finally, the recession comes, and demand is so low that prices fall again, ending the inflation. It’s not only the one known cure for inflation, it’s also an inevitable consequence of inflation.
Politicians, of course, have been determined since the year dot not to admit this, ever, at least not when they’re in charge. That’s why you get all sorts of gimmickry like those we’re seeing today – grants to help with the cost of living, and so forth, or special packages to help people with their energy bills. The problem with these measures is that they tend to make the problem worse, and weaken the country in the process. Inflation is caused by too much demand relative to supply: The more money you pump into people’s pockets, the more you artificially prolong and exacerbate the problem.
You can’t really blame politicians, though: They’d not last long in office if they were honest about the nature of the problem: “We need to get inflation under control so some of you will have to lose your jobs and all of you will have to reduce your standards of living” is not a vote winner.
But Larry Summers is not a politician, and therefore has a little bit more leeway when it comes to telling the truth about the likely path ahead. There will, of course, always be those in the markets who are determined to play down the risks of recession, because, by and large, it suits them to do so: Recessions are bad, in the main, for investors and traders and banks because share prices fall. You can also talk yourself into a recession: If everybody believes one is coming, they start selling their assets and reducing their spending, thus causing one. So, your professional economists, working for banks and financial institutions, are always a little more wary about predicting recessions than say, people like Morgan Kelly were last time out. He worked for UCD, remember, and had no real incentive to talk the economy up.
Economics is not, of course, an exact science, and there are people out there who seem to make a living predicting recessions every other month. They’re wrong more often than they are right. Larry Summers, though, is not amongst them. And this time, he’s not predicting anything particularly strange or radical. High inflation has consequences, and we may be not far off experiencing the worst of those consequences.