Summers warns Fed against ‘financial dominance’, calls for rate hike

(Bloomberg) — Former Treasury Secretary Lawrence Summers said the Federal Reserve shouldn’t be shy about easing its campaign to curb inflation due to excessive concerns about a credit crunch following the recent banking turmoil.

Bloomberg’s Most Read

“It would be most unfortunate if, out of concern for the banking system, the Fed slowed its rate of interest rate hikes beyond what was appropriate given the credit crunch,” Summers said on Bloomberg Television’s “Wall Street Week” with Davi Westin.

Fed policymakers, who meet March 21-22 to set rates, will need to recognize that slower credit creation will result from the turmoil triggered by the collapse of two banks this past weekend, according to Summers. But “the credit slowdown is not as big” as the Fed tightening that has now been removed from market prices, he said.

“I don’t think the Fed should allow financial dominance,” said Summers, a professor at Harvard University and a paid contributor to Bloomberg Television. Financial dominance is a condition where a central bank dare not tighten its policy stance as this would threaten the stability of the financial system.

“It’s appropriate – at least based on current facts, and they are changing very quickly right now, but based on current facts – to raise rates by 25 basis points” next week, Summers said.

scaring the audience

Reacting too strongly to the banking situation by changing interest rate policy could make many observers “feel that if the Fed was scared, then so should they be” — making the situation worse, Summers said. Loosening the fight to contain rising living costs could also lead to higher inflation expectations, he said.

“Ironically, this can raise inflation expectations and contract the economy,” he said. “I expect the Fed can advance 25 basis points.”

Summers reiterated his praise for the European Central Bank’s 50 basis point rate hike on Thursday and hopes ECB President Christine Lagarde’s example will be a “model” for the Fed.

“She made it very clear that with two different problems – inflation and financial stability – you can use two different instruments to respond to the problems, and not sacrifice the inflation dimension,” Summers said.

Question Deposits

On Sunday, the Fed moved to address financial stability concerns by setting up a new facility to help banks raise long-term funding in exchange for assets, including Treasuries. The aim is to contain an outflow of deposits from smaller banks.

“We can use a policy geared towards supporting depositors separately from monetary policy,” Summers said.

The former Treasury chief also warned US regulators to move too hard against regional banks after the Silicon Valley Bank problems that caused its collapse earlier this month. “Throwing the book” at all regional banks “could exacerbate a credit crunch that we don’t want to have in the long run,” he said.

Summers indicated that some reform of how deposits are considered might be in order. A key vulnerability for SVB was its reliance on unsecured corporate deposits, which were quickly withdrawn when the bank’s problems arose.

Companies like a $5 million start-up shouldn’t be in a position to assess the creditworthiness of the bank where it deposits its payroll money, according to Summers.

“I hope we move towards – over time – a financial system in which basic cash deposits are held in Treasury bills or in institutions that intermediate them in Treasury bills,” he said. “It will take a lot of thought, but there are very deep conceptual issues raised here.”

(Updates with comments on regulation and deposits in final four paragraphs.)

Most Read by Bloomberg Businessweek

©2023 Bloomberg LP

Leave a Reply

Your email address will not be published. Required fields are marked *