(Bloomberg) – Former Treasury Secretary Lawrence Summers expects US interest rates to rise in the short term and US taxes to rise significantly in the long term as the world's largest economy grapples with a persistent inflation problem and mounting public debt.
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In a dinner speech Tuesday at the Peterson Institute for International Economics, the Harvard University professor said the US appears to be stuck at an underlying inflation rate of about 4.5 to 5 percent, more than double the Federal government's 2 percent target correspond to reserve.
With previous Fed rate hikes and banking sector stress holding back the economy less than expected, it means the central bank will likely need to raise interest rates further to stem price pressures, Summers, a paid contributor at Bloomberg told TV.
“My expectation is that Fed funds need to reach a point 50 basis points or more above where they are now,” he said. Whether that comes in 25 basis-point increments or a half-point rise is secondary, he said.
Fed policymakers have given conflicting signals about what they expect to do at their upcoming June 13-14 meeting. Some appear to advocate a pause in their credit tightening campaign, while others have indicated they would like to continue.
The central bank has hiked interest rates by 5 percentage points over the past 14 months, to a target range of 5% to 5.25% for the overnight interbank federal funds rate.
Summers called the debt agreement reached between President Joe Biden and House Speaker Kevin McCarthy a “reasonable outcome,” though he questioned some of its provisions, most notably the cut in funding for the Internal Revenue Service.
The agreement sets the trajectory for federal spending through 2025 and will suspend the debt ceiling until Jan. 1, 2025 — likely delaying another dispute over the federal lending agency until mid-year. In exchange for Republican votes for the suspension, Biden agreed to cap federal spending for the next two years.
The pact, which has yet to be passed by Congress, does not significantly change the long-term fiscal outlook, Summers said.
He painted a bleak picture of the challenges facing US fiscal officials in the coming years, arguing that the situation is even worse than that portrayed by the Congressional Budget Office.
In an update to its fiscal outlook in May, the CBO projected that the U.S. fiscal deficit would widen to 7.3% of gross domestic product in fiscal 2033, due in part to higher interest rates and increased spending for America's aging population. Last year the shortfall was 5.2% and from 1973 to 2022 it averaged 3.6%.
Summers claimed that the fiscal deficit could plausibly be 11% of GDP in 2033 under assumptions other than those of the CBO. These include even higher interest rates, higher defense spending and the continuation of much of the tax cuts introduced under former President Donald Trump, which are about to expire.
“We face a challenge unprecedented in our history,” he said.
It is unrealistic to expect government spending cuts to close the gap, so Summers says higher taxes are needed.
“The US will likely need significant revenue increases over time in ways that are largely unrecognized by the political process,” he said.
The good news is that the US has some breathing room to address the problem because the country's dynamism makes it a magnet for foreign capital, he said.
In that regard, he did not believe that the country's fiscal outlook would result in problems for the dollar of the kind that the US was experiencing under former President Jimmy Carter.
“I tend to be an optimist on the dollar,” he said, arguing that the alternatives — the euro, the Japanese yen and the Chinese yuan — had their own problems.
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