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

(Bloomberg) — Former Treasury Secretary Lawrence Summers said it is important for the Federal Reserve to follow through on the monetary tightening it has signaled, even in the face of financial risks from its actions.

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“It’s a real mistake to suggest that somehow we shouldn’t do the monetary policies that are necessary to prevent inflation from fixing because of concerns about financial stability,” Summers told Bloomberg’s “Wall Street Week.” Television with David Westin. “There is a risk of some kind of economically traumatic event. But I think the chances of something big enough to derail the Fed are very low.”

The Fed’s 3 percentage point interest rate hikes since early March have pushed the dollar higher, straining economies around the world and pushing up corporate debt premiums. This has fueled a debate over whether the US central bank should slow its moves, for fear of triggering a crisis.

Summers rejected the argument that because long-term measures of inflation expectations are relatively stable, that suggests the Fed doesn’t need to move as aggressively in raising interest rates. Expectations for long-term price stability have been shaped by Fed policymakers’ promises to keep tightening, Summers said, and that makes it vital that they keep going.

“The more it’s true that expectations are not yet entrenched, despite high inflation, I think it’s more important to move forward strongly now on inflation, so that they don’t come in,” said Harvard University’s Summers . 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 an increase of 263,000 payrolls, with average hourly earnings up 5% compared to a year earlier. The unemployment rate was 3.5%, the same as the lowest in five decades.

“We have too strong an economy” to allow inflation to come down, he said. “We’re headed for a collision of one kind or another, and we just have to manage that collision carefully. And I think the sooner we start managing some of the slowdown, the better off we’ll be.”

Financial markets are expecting a fourth consecutive rate hike of 75 basis points at the Fed’s Nov. 1-2 meeting and a move of more than 50 basis points in December. Summers said he is currently aligned with that perspective. That scale “will be appropriate if we get deflation,” he said.

The former Treasury chief also cited episodes in modern central bank history of greater economic resilience following financial incidents than might have been expected.

Crash of 1987

“Every time, we’re surprised at how robust the economy remains,” he said. “In retrospect, we cut interest rates too far and kept them too low when we were supporting the financial system post-Covid.”

Looking back on monetary easing at the time of the 1997-98 Asian financial crisis and the collapse of hedge fund long-term capital management, Summers said: “We kept interest rates too low and we burst a bubble.” Stocks soared in 1998 and 1999 during the dot-com craze, then crashed, contributing to a recession.

And, “in retrospect we were surprised, surprised, 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 submit proposals to strengthen what would inevitably be inadequate financial regulation, he said.

(Updates with context on the Fed’s history in the final five paragraphs.)

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