Larry Summers is convinced the Federal Reserve will make a huge mistake if it raises interest rates next week.
Two weeks ago, Summers wrote in the Financial Times that a rate hike risked “tipping some part of the financial system into crisis.”
And in a blog post on Wednesday, the economist, who withdrew as a candidate for chair of the Federal Reserve Board, a job now held by Janet Yellen, followed up on this thinking, giving five reasons his argument against a rate hike was even stronger than it used to be.
Summers’ main points are:
- The stock market chaos two weeks ago tightened financial conditions and created the equivalent of 25 basis points of a hike (this is the amount by which most think the Fed will raise rates if it does this month). Employment growth has slowed down, and commodity prices have fallen. The Atlanta Fed’s gross-domestic-product tracking model, which nailed first- and second-quarter growth, is forecasting only 1.5% growth in Q3. The Fed has argued that low inflation is transitory. But inflation will most likely stay low, and the Fed’s preferred measure – personal consumption expenditures – is expected to be below the 2% target, according to market-based expectations. It would be pointless, as some have suggested, for the Fed to raise its benchmark rate by 25 basis points and then say there will not be more hikes for some time. “If as some suggest a 25-BP increase won’t affect the economy much at all, what is the case for an increase?” If the Fed does nothing, the “risks” are a rise in inflation and less volatility in markets. But there could be a “catastrophic error” if it tightens policy now. And according to Summers, the consensus views on the economy are understating its real risks.
At next week’s meeting, the Federal Open Market Committee will decide whether to raise its benchmark rate for the first time in nine years. But markets think it’s a remote possibility and are pricing in a 30% chance that the Fed will hike.
Summers joins the World Bank, the International Monetary Fund, and others in calling on the Fed to not raise rates just yet.