Lawrence “Larry” Summers, former U.S. treasury secretary, pauses during a session on day two of the World Economic Forum (WEF) in Davos, Switzerland. (Photographer: Jason Alden/Bloomberg)

Summers Says `Brittle' World Economy Not Ready for a Slump

(Bloomberg) -- Former U.S. Treasury Secretary Lawrence Summers warned that 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.

“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 on Tuesday. It’s the “maintenance of sound growth and getting to full employment.”

The remarks come as the world’s most powerful monetary policy makers start scaling back the extraordinary levels of support they’ve 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 brings together some of those figures, including Federal Reserve Chairman Jay Powell and European Central Bank 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.”

Federal Reserve

Last week, the U.S. Federal Reserve 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.

But 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’ll be unable to respond with the level of force necessary to effectively address the slump. 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.’

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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.”

ECB Governing Council member Philip Lane conceded that Summers had painted an accurate picture of the challenges faced by central banks but underestimated their capacity.

“What Larry didn’t focus on last night and what we will focus on as central bankers is interest-rate policy is just one of the tools,” he said in a Bloomberg interview on Tuesday. “The range of tools a central bank can use to maintain its inflation target, even during a slowdown, is wide.”


Policy Responses

In Summers’s view, central bankers should wait until they see "the whites of their eyes" of inflation threats before firing off policy responses.

He is a proponent of the idea that the economy is in secular stagnation -- a prolonged period of low growth.

"Some people think that the economies are growing, that shows that the secular stagnation theory was wrong," he said in the interview. "I have exactly the opposite view: It required enormous fiscal stimulus to get the economies to grow even reasonably adequately and that demonstrates the validity of the secular stagnation thesis."

Powell, Draghi, Bank of Japan Governor Haruhiko Kuroda and Reserve Bank of Australia Governor Philip Lowe are scheduled to appear together for a panel discussion Wednesday afternoon local time at the conference just outside Lisbon. The event is hosted by the ECB.

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