LARRY SUMMERS: I think the Fed is making these 4 mistakes right now
And of course, the Fed's main problem seems to be that they're not listening to him.
In a post on his blog on Tuesday, Summers - currently a professor at Harvard and at one time believed to be the top candidate to replace Ben Bernanke as Fed Chair (a job ultimately given to Janet Yellen) - argued that the Federal Reserve's decision to raise rates last week essentially reflects its commitment to models that are simply wrong.
And these models are wrong because they seem to view the threat of "secular stagnation" as less of a clear and present danger than Summers does.
A quick primer: Summers brought back the idea of "secular stagnation" - originally advanced by Alvin Hansen back in the 1930s - in a speech before the IMF in November 2013. The basic idea is that the world economy is not going to grow as fast as it has in the past because there is a lack of demand in the global economy. As a result, Summers has continually argued that the Fed, other central banks, and governments need to take measures to foster growth. This has meant arguing for more spending and a commitment to low interest rates.
But so in his post on Tuesday, Summers finds four main faults with how the Fed has proceeded in recent months, first by telegraphing that interest rates were coming and then by actually doing it.
First, Summers doesn't think there's as much reason as the Fed seems to believe that inflation will return to its 2% target. In a related critique (this counts as #2), Summers thinks the Fed is acting as if 2% inflation is a ceiling, not a target (despite Yellen's protestations to the contrary).
The basic complaint here is that Summers and others think the Fed should be willing to let inflation "run hot" and overshoot the Fed's 2% target. By raising rates with inflation still well below that number - coming in at around 1.3% annually at last check - the Fed risks putting pressure on an economy unable to handle any.
Third, Summers thinks the idea that the Fed needs to raise rates now in order to lower them in the future in response to an economic shock is misguided. And while this is a common critique and one we'd agree with, this has become something like a straw man critique of Fed action because it isn't clear the Fed itself is really using this as a justification. Either way.
Finally, Summers says the Fed is underestimating secular stagnation. Summers writes, "Fourth, the Fed is likely underestimating secular stagnation. It is failing to recognize its transmission from the rest of the world and it is overestimating the degree of monetary accommodation now present and likely to be present in the future by overestimating the neutral rate. I suspect that if nominal interest rates were 3 percent and inflation were far below target there would be much less pressure to raise them than there has been of late."
This is, of course, the relevant point: the Federal Reserve is not listening to Larry Summers as much as Summers thinks they should.
Read Summers' full post here »