(Bloomberg) — Former Treasury Secretary Lawrence Summers said it’s important the Fed follows through on additional monetary tightening he has 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 should somehow not pursue the monetary policies that are necessary to prevent inflation from taking hold because of concerns about financial stability,” Summers told Bloomberg Television’s “Wall Street Week” with David Westin. “There is a risk of some kind of financially traumatic event. But I think the chances of anything being big enough to throw the Fed off track are pretty low.”
The Federal Reserve’s 3 percentage point interest rate hikes since early March have pushed the dollar higher, putting pressure on economies around the world and driving up corporate debt premiums. That 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, that suggests the Fed doesn’t need to move as aggressively to raise interest rates. Expectations for long-term price stability have been shaped by promises from Fed policymakers to tighten further, Summers said, and that makes it vital that they keep going.
“The more certain it is that expectations are not yet ingrained, despite high inflation, it seems to me that the more important it is to move vigorously now with respect to inflation, so that they don’t become ingrained,” said Summers, a student at the University of Harvard. professor and paid contributor to Bloomberg Television.
collision management
Friday’s jobs report underscored that “we have an inflation problem,” Summers also said. September saw a 263,000 increase in payrolls, with average hourly earnings up 5% compared to the prior year. The unemployment rate was 3.5%, matching a five-decade low.
“We have an economy that is too strong” to allow inflation to subside, he said. “We are heading into a collision of one kind or another, and we have to handle that collision carefully. And I think the sooner we start to handle a slowdown, the better we’ll do.”
Financial markets anticipate a fourth consecutive rate hike of 75 basis points at the Fed meeting on November 1-2, and a further 50 basis point move in December. Summers said that he is currently aligned with that perspective. That scale “is going to be appropriate if we achieve disinflation,” he said.
The former Treasury chief also cited episodes in modern central banking history of greater economic resilience after financial mishaps than might have been expected.
1987 accident
“Each time, we are surprised by how strong 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.”
Looking back at the monetary easing at the time of the 1997-98 Asian financial crisis and the collapse of the hedge fund Long-Term Capital Management, Summers said, “We kept interest rates too low and we burst a bubble.” Stocks rose in 1998 and 1999 during the dot-com craze, then crashed, contributing to a recession.
And, “in hindsight, 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 think a 4.5% Fed policy rate would cause “substantial financial disruption” should come up with proposals to strengthen what would inevitably be inadequate financial regulation, he said.
(Updates with context on the Fed story in the last five paragraphs.)
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