Summers warns Fed against “financial dominance” and calls for rate hike

(Bloomberg) — Former Treasury Secretary Lawrence Summers said the Federal Reserve should not be afraid to ease its inflation-control campaign out of undue concern about a credit crunch in the wake of the recent banking turmoil.

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“It would be very unfortunate if, out of concern for the banking system, the Fed slowed rate hikes beyond what is appropriate given the credit crunch,” Summers told Bloomberg Television’s “Wall Street Week” David Westen.

Fed policymakers, who meet March 21-22 to set interest rates, must recognize that slower credit creation will result from the turmoil sparked by last weekend’s collapse of two banks, Summers said. But “the slowdown in lending is nowhere near as severe” as the Fed’s tightening, which has now been removed from market prices, he said.

“I think the Fed shouldn’t allow financial dominance,” said Summers, a Harvard University professor and a paid contributor to Bloomberg Television. Financial dominance is a state in which a central bank dares not tighten its monetary policy stance as this would endanger the stability of the financial system.

“It’s appropriate — at least on current facts, and they change very quickly these days, but on current facts — to raise interest rates by 25 basis points next week,” Summers said.

scare the public

Overreacting to the banking situation by changing interest rate policy could make many observers “feel that if the Fed is scared, they should be too” — making the situation worse, Summers said. An easing of the fight to contain cost-of-living growth could also lead to higher inflation expectations, he said.

“Ironically, it could both raise inflation expectations and contract the economy,” he said. “I hope the Fed can move up 25 basis points.”

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

“She made it very clear that if you have two different problems — inflation and financial stability — you can use two different tools to respond to the problems and you don’t have to sacrifice the inflation dimension,” Summers said.

The Fed moved to address financial stability concerns on Sunday by establishing a new facility to help banks obtain long-term funding in exchange for assets, including government bonds. The aim is to curb an outflow of deposits from smaller banks.

“We can employ policies that aim to stand behind depositors, separate from monetary policy,” Summers said.

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