Why Larry Summers Thinks We Need High Unemployment to Combat Inflation

  • In a speech over the weekend, former Treasury Secretary Larry Summers said he believes the U.S. would need 6% unemployment to ease inflation.
  • 6% over five years or 10% over one year is, according to Summers, necessary to lower price levels.
  • Employment has generally held strong this year, adding nearly 400,000 jobs last month amidst rampant inflation.
high unemployment - Why Larry Summers Thinks We Need High Unemployment to Combat Inflation

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Five years of unemployment above 5% — that’s what former Treasury Secretary Larry Summers believes is necessary to lower inflation. In a speech in London this weekend, Summers stated high unemployment was likely the U.S.’s path to easing price levels.

“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. There are numbers that are remarkably discouraging relative to the Fed Reserve view.”

Should unemployment rise to Summers’ ideal level, an additional 10 million Americans would effectively lose their jobs. The current figure is 6 million people.

On a macroeconomic level, Summers’ view isn’t without merit. Inflation has an inverse relationship with unemployment, meaning that as inflation climbs, unemployment should generally fall, and vice versa. Currently, that’s exactly what’s happening. As per the May Consumer Price Index (CPI) report, prices jumped 8.6% year-over-year as of last month. This represents the highest level for the index since the 1980s.

Even as inflation rears its increasingly ugly head, however, jobs numbers this year have held strong. In the May Employment Situation Summary, employment shows rose 390,000 last month, representing a contextually strong 3.6% unemployment rate.

So, why does Summers believe we’ll need to nearly double the current unemployment rate to ease off inflation?

Summers’ Case for High Unemployment

In a theoretical sense, more unemployed would beget lower prices. With fewer employed Americans, a smaller number of people have discretionary income. That means the country’s aggregate demand for goods is lower, effectively putting downward pressure on price levels.

The rampant inflation this year is largely attributable to a mismatch between supply and demand. The Russian invasion of Ukraine and subsequent trade sanctions put on Russia combined with China’s Covid-19-related lockdown this year have put extraneous stress on supply chains worldwide. Things like energy have risen more than 30% in price from last year as a result of this supply shortage.

All the while, demand for goods has remained relatively stable in the U.S. in part due to strong employment numbers. High demand and low supply for goods is the most basic logic behind the currently elevated price levels. So, as Summer believes, should unemployment take a turn for the worse, inflation would likely ease as a result. He added:

“The gap between 7.5% unemployment for two years and 4.1% unemployment for one year is immense. Is our central bank prepared to do what is necessary to stabilize inflation if something like what I’ve estimated is necessary?”

Article printed from InvestorPlace Media, https://investorplace.com/2022/06/why-larry-summers-thinks-we-need-high-unemployment-to-combat-inflation/.

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