Summers sees higher Fed interest rates and higher US taxes

(Bloomberg) – Former Treasury Secretary Lawrence Summers sees U.S. interest rates rising in the short term and U.S. taxes rising significantly in the long term as the world’s largest economy grapples with a crisis. persistent inflation and soaring public debt.

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Speaking over dinner at the Peterson Institute for International Economics on Tuesday, the Harvard University professor said the United States appeared to be stuck with an underlying inflation rate of around 4.5% to 5%, more than double the Federal Reserve’s 2% target.

With past Fed rate hikes and strains in the banking sector exerting less of a strain on the economy than expected, this means the central bank will likely need to raise the fed funds rate further to reduce price pressures, said said Summers, a paid Bloomberg contributor. TV.

“I guess the fed funds are going to have to get 50 basis points or more ahead of where they are,” he said. Whether that’s via 25 basis point increments of a half point hike is of secondary importance, he said.

Fed policymakers gave mixed signals about what they are likely to do at their next meeting on June 13-14, with some appearing to support a pause in their credit-tightening campaign while others indicated that would like to move forward.

The central bank has raised rates by 5 percentage points over the past 14 months, within a target range of 5% to 5.25% for the interbank overnight federal funds rate.

Summers called the debt deal struck between President Joe Biden and House Speaker Kevin McCarthy a “reasonable outcome,” though he took issue with some of its provisions, particularly its 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 Jan. 1, 2025 — likely postponing another battle over federal borrowing power until the middle of this year. In exchange for Republican votes to suspend, Biden agreed to cap federal spending for the next two years.

The pact, which has yet to be passed by Congress, doesn’t change the long-term fiscal outlook much, Summers said.

Tax challenge

He painted a dire picture of the challenges facing US budgetmakers in the years to come, saying the situation is even worse than described by the Congressional Budget Office.

In an update to its fiscal outlook in May, the CBO projected that the U.S. budget deficit would reach 7.3% of gross domestic product in fiscal year 2033, partly due to rising interest rates and the increase in expenditure linked to the aging of the American population. Last year the deficit was 5.2% and from 1973 to 2022 it averaged 3.6%.

Summers argued that the budget deficit could likely reach 11% of GDP in 2033 under different assumptions than the CBO. They include even higher interest rates, increased defense spending and the continuation of the bulk of the tax cuts initiated under former President Donald Trump that are set to expire.

“We have before us a challenge of an unprecedented scale in our own history,” he said.

It is unrealistic to expect to close the gap through government spending cuts and therefore higher taxes will be needed, according to Summers.

“The United States, over time, in a way that is largely unrecognized by the political process, will likely demand substantial increases in revenue,” he said.

The good news is that the United States has leeway to tackle the problem because the country’s dynamism makes it a magnet for foreign capital, he said.

In that regard, he did not see the country’s fiscal outlook leading to the kind of problems for the dollar that the United States experienced under former President Jimmy Carter.

“I tend to be bullish on the dollar,” he said, saying the alternatives – the euro, Japanese yen and Chinese yuan – have their own problems.

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