LARRY SUMMERS: 'The Fed is not credible with the markets'

Larry Summers isn’t mincing words when it comes to Federal Reserve policy: he thinks it’s way off.

In a stinging new post in the Washington Post’s Wonkblog, the former Treasury Secretary and Harvard economist says the central bank has lost crediblity with financial markets because of its consistently misguided optimism about growth prospects and the Fed’s ability to raise interest rates.

“The Fed is not credible with the markets at this point,” Summers writes. “Its dots plots predict four rate increases over the next 18 months compared with the markets’ expectation of less than two.”

Summers is not so concerned with this week’s interest rate increase itself, but rather with the way Fed officials think about the tradeoff between inflation and employment, a construct economists call the Phillips Curve.

“The Fed has been highly unrealistic in its forecasts for several years,” he points out.

Summers suggests that by allowing inflation to consistently undershoot its 2% target, the Fed is not only missing an opportunity to create millions more jobs, but also placing the economy in a needlessly precarious position.

“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,” he writes.

Some economists have recently advocated the Fed adopt a higher inflation target, which Summers says “would entail easier policy than is now envisioned.”

Fed Chair Janet Yellen, once averse to the idea, appears to be warming up to the notion after years of falling short of her official inflation goal.

At the very least, Summers says, “the Fed should be consistent with its mandate and let inflation rise above 2%.” The Fed says its 2% target is “symmetric,” meaning inflation should spend as much time above the goal as it does below it. Yet the official rate has remained below that level for the bulk of an economic expansion that began in 2009, and followed the deepest recession in generations.

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