Fed Inflation Risk Puts Summers at Odds With Krugman

(Bloomberg) -- Former U.S. Treasury Secretary Lawrence Summers said he disagrees with fellow economist Paul Krugman’s argument that the Federal Reserve should bide its time before raising interest rates because inflation will prove transitory and it’s not worth risking a recession.

Speaking on Bloomberg Television’s “Wall Street Week” with David Westin, Summers reiterated his view that the Fed is too focused on removing slack from the labor market and, by doing so, is allowing the economy and inflation to overheat.

It’s better to act now and slow the economy than have to clamp down harder later -- when the chance of a deeper recession would be greater, Summers said. 

“If you look ahead of you and you see that there might be all the traffic stopped, you start braking your car as early as you can -- even if it means that it’s going to slow you down in the event that there is no traffic jam,” said Summers, a paid contributor to Bloomberg. “That’s, I think, the right way to think about the central bank’s problem right now.”

Nobel laureate Krugman wrote in the New York Times last week that “raising rates too soon could turn out to be a big mistake, since the Fed won’t have much room to cut rates if demand weakens.”

The Fed this week said it will begin slowing its asset-purchase program, but Chair Jerome Powell said he preferred to practice patience on raising interest rates because the labor market has room to heal further and inflation should still fade in time.

“If we let inflation accelerate, there’s almost no proven ability at the central bank to engineer a soft landing,” Summers said. “In order to squeeze out an extra bit of hoped-for labor market tightness, we’re taking a real risk that we’re setting up for a very serious problem.”

Summers said Friday’s employment report from the Labor Department underscored that “we’ve got a very, very strong economy on the demand side and not a very strong economy on the supply side. That’s risking an overheating.”

Nonfarm payrolls increased by 531,000 last month, while the unemployment rate fell to 4.6% and the labor force participation rate was unchanged.

“I don’t think we’ve got a strong basis for thinking that participation is going to rally in a major way,” said Summers.

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