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Larry Summers: 5 Reasons Why Fed May Be Making a Mistake

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                Larry Summers: 5 Reasons Why Fed May Be Making a Mistake

Larry Summers, the former U.S. treasury secretary who last year said the U.S. should stop printing $100 bills and that the Federal Reserve may need to consider buying stocks to stimulate the economy, said the central bank might be making a mistake by raising interest rates while inflation is still low.

The Fed on Wednesday raised its target rate by 0.25 percentage point to a range of 1 percent to 1.25 percent, the highest in nine years, on signs that the U.S. economy is growing steadily while the unemployment rate of 4.3 percent is at a 16-year low.

Summers is most concerned that inflation isn't rising strongly enough to indicate healthy demand for products and services. The consumer price index last month rose 1.9 percent from a year earlier. 

“Moving away from inflation targeting to something like nominal gross domestic product-level targeting would be a better idea,” Summers said in the Washington Post. “But I think that this issue is logically subsequent to the question of how policy should be made in the near term with the given 2 percent inflation target.”

Summers has five reasons to doubt the Fed’s current policy of tightening credit.

The Fed is not credible with the markets at this point. “The truth is that markets do not share the Fed’s view that inflation acceleration is a major risk.Indeed they do not believe the Fed will attain its 2 percent inflation target for a long time to come.”
The Fed regularly proclaims that it has a symmetric commitment to its 2 percent inflation target. “Policy should be set with a view to modestly raise target inflation, perhaps 2.3 or even 2.5 percent inflation, during a boom with the expectation that inflation will decline during the next recession.A higher inflation target would entail easier policy than is now envisioned.”
Preemptive attacks on inflation, such as preemptive attacks on countries, depend on the ability to judge threats accurately.“With inflation and inflation expectations below target and declining, there would be little case for preemption even if inflation above target was a serious problem.But as we have seen, there are strong reasons for thinking that the Fed should to be consistent with its mandate and let inflation rise above 2 percent.”
There is good reason to believe that a given level of rates is much less expansionary than it used to be given the structural forces operating to raise saving propensities and reduce investment propensities. “I am not sure that a 2 percent funds rate is especially expansionary in the current environment.And I am confident that if the Fed errs and tips the economy into recession the consequences will be very serious.”
A “whites of their eyes” paradigm [of raising rates when inflation starts to roar] does not require the Fed to abandon its connection to price stability.“It simply needs to assert that its objective is to assure that inflation averages 2 percent over long periods of time."

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