Larry Summers warns of a dreaded economic ‘Doom Loop’ and says America should pay attention to the UK’s troubles

“That would be a real mistake” to conclude that other countries wouldn’t end up confronting similar challenges, Summers told Bloomberg Television’s “Wall Street Week” with David Westin. The first lesson from the UK is “that things can change extraordinarily fast.”

Governments need to pay increasing attention to their budgets, with mounting deficits alongside surging borrowing costs having the potential for shaking confidence, he said. In the US, student-loan forgiveness, emergency funding for Hurricane Ian and rising defense spending needs suggest that fiscal debates will need to be “back on the table,” he said.

“If your deficit projection starts to get out of control and your real interest rates start to rise rapidly, you can get into a kind of doom loop,” said Summers, a Harvard University professor and paid contributor to Bloomberg Television. “We’re going to need to be watching our own fiscal projections in the United States very carefully.”

Outgoing UK Prime Minister Liz Truss abandoned a program of unfunded tax cuts after its unveiling prompted a destabilizing selloff in UK government bonds.

Yellen on Friday recognized the importance of having “a credible fiscal policy and to make sure the debt is sustainable over time,” and argued that “our budgets have done that.” She hailed fresh data showing an historic drop in the deficit. 

Yellen’s Take

“I do see our debt as being on a responsible path,” Yellen said in answering questions from reporters.

Summers said that a further risk stemming from government debt markets is the concern with deteriorating trading conditions. He endorsed Treasury Secretary Janet Yellen’s recent expression of concern over a “loss of adequate liquidity” in US Treasuries.

While rising borrowing costs are escalating the risks, Summers cautioned that it would be unwise for the Federal Reserve to be dissuaded from continuing with its plans for aggressive interest-rate hikes. Failing to follow through would mean “stagflation,” with high inflation making an economic downturn all the worse.

Inflation is at risk of getting fresh impetus from a spike in oil prices, the former Treasury chief also said. He worried over US “confrontation” with what he described as a “Russian-Saudi axis.” The Biden administration has blasted Saudi Arabia’s recent push to reduce oil production, while it’s also pursuing an oil-price cap on Russian crude.

“This is going to be a very complex time and I hope that we get through it while avoiding oil price spikes,” he said. But “my guess is that that’s going to happen,” he added.

‘Downside Wildcard’

A renewed spike in oil is “a major downside wildcard from here, both with respect to inflation, and with respect to recession.”

Once the US does enter a recession, Washington will need to be careful with regard to deploying any fiscal support package, Summers also said — given the danger of a negative response in the bond market. It’s one consequence of having rapidly run up government borrowing in recent years, he said.

“Unfortunately, I think we fired the fiscal cannon so strongly that there’s going to be limited room for discretionary fiscal policy if we have another recession,” he said.

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