(Bloomberg) – Former Treasury Secretary Lawrence Summers said it was important for the Federal Reserve to hold on to the new monetary tightening it signaled, even in the face of financial risks stemming from its actions.
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“It’s a real mistake to suggest that we shouldn’t pursue the monetary policies necessary to prevent inflation from taking root because of financial stability concerns,” Summers told Wall Street Week. Bloomberg Television with David Westin. “There is a risk of some sort of financially traumatic event. But I think the odds of anything being big enough to hijack the Fed are really, really low. »
Interest rate hikes of 3 percentage points from the Fed since the start of March have propelled the dollar higher, straining economies around the world and pushing up premiums on corporate debt. This has fueled a debate over whether the US central bank should slow its moves for fear of triggering a crisis.
Summers dismissed the argument that because measures of long-term inflation expectations are relatively stable, it suggests the Fed doesn’t need to act as aggressively to raise interest rates. Expectations for longer-term price stability have been shaped by promises from Fed policymakers to keep tightening, Summers said — and so it’s vital for them to follow through.
“The more true that expectations are not yet entrenched, despite high inflation, it seems to me that it is more important to act vigorously now on inflation – so that they do not become entrenched “, said Summers, a researcher from Harvard University. professor and paid contributor to Bloomberg Television.
Collision management
Friday’s jobs report pointed out that “we have an inflation problem,” Summers also said. In September, payrolls increased by 263,000, with the average hourly wage increasing by 5% compared to the previous year. The unemployment rate was 3.5%, corresponding to a five-decade low.
“We have too strong an economy” to allow inflation to come down, he said. “We are heading for a collision of one kind or another, and we just have to handle that collision carefully. And I think the sooner we start to deal with some downturn, the better off we’ll be.”
Financial markets are pricing in a fourth consecutive rate hike of 75 basis points at the Fed’s November 1-2 meeting, and another 50 basis point hike in December. Summers said he is currently aligned with that prospect. This scale “will be appropriate if we achieve disinflation,” he said.
The former Treasury chief also cited episodes in modern central bank history of greater economic resilience following financial mishaps than might have been expected.
1987 accident
“Each time, we are surprised at how robust the economy remains,” he said. “In retrospect, we cut interest rates too much and kept them too low when we were supporting the financial system after Covid.”
Returning to monetary easing at the time of the 1997-98 Asian financial crisis and the collapse of the Long-Term Capital Management hedge fund, Summers said: “We kept interest rates too low and blew up a bubble. Stocks surged in 1998 and 1999 during the dot-com mania, then crashed, contributing to a recession.
And, “In retrospect, we were surprised — amazed — at how quickly the economy grew when the Fed did what was necessary after the stock market crash of 1987,” Summers said.
Those who believe a 4.5% Fed policy rate would cause “substantial financial disruption” should come forward with proposals to tighten what would inevitably be inadequate financial regulation, he said.
(Updates with context on the history of the Fed in the last five paragraphs.)
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