(Bloomberg) — Former Treasury Secretary Lawrence Summers sees US interest rates rising in the near term and US taxes rising significantly in the longer term as the world’s largest economy comes to grips with a lingering inflationary problem and burgeoning government debt.
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In a dinner address at the Peterson Institute for International Economics on Tuesday, the Harvard University professor said the US appears to be stuck at an underlying inflation rate of around 4.5% to 5%, which is more than double the target of 2 % of the Federal Reserve.
With previous Fed rate hikes and banking sector stress holding the economy less than expected, this means the central bank will likely need to raise Federal Fund rates further to ease price pressures, Summers said. paid employee of Bloomberg. TV.
“My guess is that Fed funds will have to move forward 50 basis points or more from where they are,” he said. Whether that’s via 25 basis point increments or a half-point increase is secondary, he said.
Fed policymakers have given conflicting signals about what they are likely to do at their upcoming June 13-14 meeting, with some appearing to support a pause in their credit-tightening campaign, while others have indicated they want to continue.
The central bank has raised 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 deal between President Joe Biden and House Speaker Kevin McCarthy a “reasonable outcome,” though he disagreed with some of its provisions, most notably the reduction in appropriations for the Internal Revenue Service.
The deal sets the course for federal spending through 2025 and will suspend the debt ceiling until January 1, 2025 — likely postponing another fight over federal borrowing power until the middle of that year. In exchange for Republican votes for the suspension, Biden agreed to limit federal spending for the next two years.
The pact, which has yet to be passed by Congress, doesn’t change much about the long-term fiscal outlook, Summers said.
He painted a bleak picture of the challenges facing US fiscal policymakers in the coming years, arguing that the situation is even worse than the one outlined by the Congressional Budget Office.
In an update to its budget outlook in May, the CBO predicted the U.S. budget deficit would widen to 7.3% of gross domestic product in fiscal year 2033, due in part to higher interest rates and increased spending on America’s aging population. Last year the deficit was 5.2% and from 1973 to 2022 it averaged 3.6%.
Summers maintained that the budget deficit could plausibly reach 11% of GDP in 2033 under assumptions other than those of the CBO. They include even higher interest rates, increased defense spending, and a continuation of most of the tax cuts introduced under former President Donald Trump that will soon expire.
“We face a challenge of a magnitude unprecedented in our own history,” he said.
According to Summers, it is unrealistic to expect the gap to be closed by government spending cuts, so higher taxes will be needed.
“The U.S. will likely need significant increases in revenue over time, in ways 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 didn’t see the country’s fiscal outlook leading to the kind of dollar problems the US experienced under former President Jimmy Carter.
“I tend to be bullish on the dollar,” he said, arguing that the alternatives — the euro, the Japanese yen and the Chinese yuan — have their own problems.
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