Summers Urges Fed to Keep Tightening, Even as ‘Collision’ Looms

(Bloomberg) — Former Treasury Secretary Lawrence Summers said it was important that the Federal Reserve deliver on the further monetary tightening it has signaled, even given the financial risks posed by its actions.

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“It’s a real mistake to suggest that we somehow shouldn’t conduct the monetary policy necessary to prevent inflation from taking hold because of financial stability concerns,” Summers told Wall Street Week Bloomberg Television with David Westin. “There is a risk of a financially traumatic event. But I think the odds of something big enough to distract the Fed are really pretty slim.”

The Fed’s 3 percentage point rate hikes since early March have boosted the dollar, weighed on economies around the world and pushed up corporate debt premia. That has fueled debate over whether the Federal Reserve should slow its steps for fear of triggering a crisis.

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Summers dismissed the argument that given that measures of longer-term inflation expectations are relatively stable, the Fed would suggest not raising rates as aggressively. Expectations for longer-term price stability have been shaped by promises by Fed policymakers to continue tightening, Summers said — making it vital for them to abide by them.

“The more it’s true that expectations aren’t solidified despite high inflation, the more important it seems to me to be tough on inflation now — to keep it from taking hold,” said Harvard University professor and paid researcher Summers by Bloomberg Television.

collision management

Friday’s job report underscored that “we have an inflation problem,” Summers said. In September, payrolls rose by 263,000, with average hourly wages up 5% from a year earlier. The unemployment rate was 3.5%, a five-decade low.

“We have an economy that is too strong” to allow inflation to fall, he said. “We’re heading for some kind of collision and we just have to handle that collision carefully. And I think the sooner we start managing a slowdown, the better off we’re going to be.”

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Financial markets are expecting a fourth straight 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 currently agrees with that prospect. That magnitude will be “appropriate if we achieve disinflation,” he said.

The former chief financial officer also cited episodes in the history of modern central banks where financial disasters have resulted in greater economic resilience than might have been expected.

1987 crash

“We’re always amazed at how much the economy retains its resilience,” he said. “In hindsight, we cut interest rates too much and kept them too low when supporting the post-Covid financial system.”

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Looking back on 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 burst a bubble.” Stocks rallied in 1998 and 1999 during the dot-com mania skyrocketed, then plummeted, contributing to a recession.

And “in hindsight, we were surprised — amazed — by how quickly the economy grew when the Fed did what was needed after the 1987 stock market crash,” Summers said.

Those who think a Fed policy rate of 4.5% would lead to “significant financial slumps” should make proposals to strengthen what would inevitably be inadequate financial regulation, he said.

(Updates with context on Fed history in last five paragraphs.)

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