Developed countries are badly equipped for another recession, both economically and politically, and central banks should be wary of raising interest rates just to control inflation, former US secretary of the treasury Lawrence Summers said.
“The issue that’s preoccupied monetary policy for the generation before the financial crisis — the avoidance of inflation — is no longer the top issue,” Summers said in a Bloomberg Television interview with Stephanie Flanders yesterday. It’s the “maintenance of sound growth and getting to full employment.”
The remarks come as the world’s most powerful monetary policymakers start scaling back the extraordinary levels of support they have lent their economies since the financial crisis a decade ago.
Summers was echoing comments he made late on Monday, at the opening of an event in Portugal that brought together some of those figures, including US Federal Reserve Chairman Jay Powell and European Central Bank (ECB) President Mario Draghi.
Asked about those who say economies have recovered since the financial crisis, Summers said that massive stimulus — including a fiscal boost and unsustainable stock market gains — has obscured the full picture.
“It may be that if policy stays on guard with relatively expansionary monetary policy, with fiscal policies that are traditionally regarded as imprudent, we may keep this going for a while,” he said. “But we’re living with a very brittle economy.”
Last week, Fed raised interest rates by a quarter percentage point and signaled a faster pace of future increases, and the ECB announced it will taper its bond purchase program.
However, even with many central banks now on the path to more normal policy settings, Summers said interest rates are unlikely to return to historically normal levels before the next recession.
That means they will be unable to respond with the level of force necessary to effectively address the slump, he said.
He called on central banks to complement their standard price-stability mandates with a policy of maximum sustained full employment.
“Downturns happen,” Summers said in the Bloomberg interview. “When they happen, the normal playbook is to cut interest rates by 500 basis points, but there’s not going to be that kind of room.”
He also said the effects from another economic downturn “dwarf and massively exceed any adverse consequences associated with inflation pushing a bit above 2 percent.”
In his view, central bankers should wait until they see “the whites of their eyes” of inflation threats before firing off policy responses.
Summers is a proponent of the idea that the economy is in secular stagnation — a prolonged period of low growth.
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