Larry Summers says lower spending could cause a recession

With inflation at risk of rising further, strong consumer spending is no guarantee and the economy would look very different if Americans cut back on their purchases. According to economist and former Treasury Secretary Larry Summers, that moment may be closer than you think.

“My guess is that the backlog, the savings that consumers have accumulated, has a few more months to go, but not another year,” Summers said Monday in an interview with CNN’s Poppy Harlow.

Summers said the economy could be approaching a “Wile E. Coyote moment,” an indication of this Looney toons Character with a tendency to chase an elusive Road Runner off the edge of a cliff when he finally realizes his mistake and begins to fall.

The same could happen to the US economy, Summers said; It could run off a cliff edge, and once its legs are dry, nothing will stop it from falling to the bottom.

“I used the term ‘risk of a Wile E. Coyote moment’ to refer to the fact that the economy could go into a bubble in a few months,” he said.

The buffer of the economy

For months, Summers has been largely pessimistic about the US economy’s chances of avoiding a recession. Even as notable economists, including Nobel laureate Paul Krugman, pointed to positive inflation data as reason to believe a soft landing was possible if not likely, Summers warned that a recession was “more likely than not.”

Economists had good reason to be optimistic in the final months of 2022, and brisk consumer spending was a big part of that. Despite rising inflation, spending has been stable for months. Households spent large sums on goods in the early days of the pandemic but saved even more due to social distancing lockdowns. Spending has hit new highs in recent months, rising 1.8% in January, according to the Commerce Department. Contributing to this is that Americans are finally spending money on services again, most people who want a job have one, and wages are rising.

But that doesn’t mean spending will stay high forever. The main source of Americans’ prodigality, their pandemic savings, may have dried up months ago.

According to Northwestern Mutual, the percentage of after-tax income Americans put into their savings accounts fell from 8.4% in December 2021 to 6.2% in March 2022. In December, Americans’ personal savings rate fell to near its all-time low.

In July, Moody’s Analytics chief economist Mark Zandi predicted that savings for low-income Americans could run out within six months, with wealthier households not far behind. That deadline has now passed, and many Americans may have already used up most of their savings, as the number of credit cardholders with credit card debt is now 46%, up from 39% a year ago, said Ted Rossman, senior industry analyst at Bankrate wealth Last month.

With consumer spending accounting for around 70% of US GDP, it all adds up to a thinner buffer zone for Americans to avoid a slowdown in economic growth and a recession. But with inflation proving tougher to bring down than some economists predicted just months ago, consumer spending could dry up at the worst possible time.

“I don’t think there’s no question, Poppy, that we don’t have inflation on a safe glide path near 2 percent yet anyway,” Summers told CNN. He added that until the Federal Reserve is confident that inflation is on a steady path to normality, interest rates will continue to rise, making borrowing more expensive and potentially pushing consumers to save rather than spend.

“My guess is that the process of bringing inflation down will eventually lead to a recession, as has almost always been the case in the past,” Summers said. “Between the risk of inflation and the risk of some kind of air pocket, the Fed is trying to walk a very, very fine line, and it’s not a very easy situation.”

wealthThe CFO Daily Newsletter is the analysis every finance professional needs to read to get ahead. Sign up today.