The Federal Reserve should be open to raising interest rates by a half percentage point in July if it opts to hold off from tightening credit this month, former Treasury Secretary Lawrence Summers said.
“We are again in a situation where the risks of overheating the economy are the primary risks that the Fed needs to be mindful of,” the Harvard University professor said in an interview with Bloomberg Television’s David Westin on Friday.
Federal Reserve Governor Philip Jefferson – who has been nominated to become vice chair — signalled on May 31 that the central bank is inclined to keep interest rates steady at its June 13-14 meeting to give policymakers more time to assess the economic outlook.
While it’s a close call whether or not to raise rates this month, Summers said the lower-risk strategy would be for the central bank to do so.
“If they don’t raise rates in June, I think they have to be open to the possibility that they may have to raise rates by 50 basis points in July if the economy continues to stay way hot and if inflation figures are robust,” said Summers, who is a paid contributor to Bloomberg TV.
He said the May jobs numbers released on Friday were “strong” on balance.
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While the unemployment rate jumped to 3.7% from 3.4% in April, data from the household survey from which the jobless figures are drawn can be noisy, especially in May when schools let out, according to Summers. The payrolls data showed companies added 339,000 workers last month after an upwardly revised 294,000 in April.
“We’ve still got a tight, hot labour market,” the former Treasury chief said.
See also: Fed to hold interest rates steady but start considering cuts
Noting that economic forecasters have underestimated the strength of payroll gains for 14 straight months, Summers said that suggested they are exaggerating the impact of monetary policy on the economy.
The central bank has raised rates 5 percentage points in the past 14 months, to a target range of 5% to 5.25% for the overnight interbank federal funds rate.
Summers again voiced scepticism that the Fed can achieve a soft landing of the economy, though he suggested that a recession might be put off until next year.
“I think the Fed will end up doing enough to restrain inflation,” he said. “That’s going to mean a quite soft economy sometime in 2024.”
Looking further ahead, Summers echoed comments he made at the Peterson Institute for International Economics earlier in the week on the dire outlook for the nation’s finances, arguing that the situation is even worse than that depicted by the Congressional Budget Office.
In an update to its budget outlook in May, the CBO forecast that the US budget deficit would rise to 7.3% of gross domestic product in fiscal year 2033, in part driven by higher interest rates and increased spending on America’s aging population. The shortfall last year was 5.2% and from 1973 through 2022 it averaged 3.6%.
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Summers maintained that the budget deficit could plausibly come in above 10% of GDP in 2033 under different assumptions than those made by the CBO. They include even higher interest rates, stepped-up defense spending and a continuation of the bulk of tax cuts initiated under former President Donald Trump that are set to expire.
Given the potential dangers out there, from a warming climate to the risk of another pandemic, the US needs to put its fiscal house in order, according to Summers.
“We’ve got to be preparing for contingencies,” he said. “This is a time when we need to be reloading in terms of the fiscal situation.”
