Macro Thinker

Janet L. Yellen, Chair of The Fed

Octavian Report: You've commented that the Fed is tightening too much, too quickly -- can you give your thinking on that?

Lawrence Summers:  There are a number of points. One, inflation is below target and is expected to remain below target for 10 to 20 years, even by markets -- they are expecting the Fed not to raise rates very much at all. And so, in the face of that, I am not sure why you'd be confident that we need to raise rates in order to hit the inflation target. Second, I think that if you're serious about a symmetric target, you have to be prepared to exceed that target sometimes. If now -- after nine years of recovery and with years more forecast and an unemployment rate below 4.5% -- is not the moment to exceed the two percent target, then I don't know when that moment would ever come.

So it seems to me desirable to be planning for a mild excess above the two percent target that will be worked off inadvertently whenever the next recession comes.

Third, we should apply risk analysis to these things. If we turn out to be wrong, and inflation rises, it will be easy to respond. If we turn out to be wrong, and inflation declines, we've seen around the world that once you get to very low inflation, it's very difficult to get out of that situation. The last thing I'd say is that the Phillips curve has not looked like a strong, reliable statistical relationship for a generation now. In that context, I'm not sure that we should be relying on it as the basis for our monetary policy going forward.

OR: How do you assess the Fed's performance over the past decade? Would you have done anything differently?

Summers: We had a situation that could have been a Great Depression. It wasn't really anything like the Great Depression. It wasn't 100 percent obvious that that would be the case. So I'd give the Fed quite high grades overall. That being said, as you noted, I have been critical of the Fed’s tendency to want to “normalize” and thereby tighten unnecessarily in my view.

OR: How will central banks ever be able to normalize policy with the amount of debt they carry and the size of their balance sheets?

Summers: Because the major central banks are able to pay interest on reserves, large balance sheets are unlikely to be a serious impediment to policy normalization. The Fed has shown the ability to raise rates even with a balance sheet four times as large as pre-Crisis levels. I think that over time central banks should try to normalize their balance sheets.  However, it can be a gradual process in which they simply allow their bonds to mature without reinvesting the proceeds.

OR: What do you think is missing from central bankers' toolboxes that needs to be there for them to be truly effective?

Summers:  I think it is past time that central bankers reassessed their operating frameworks based upon lessons from the Crisis. Ideas like moving to a nominal GDP target or raising the inflation target should be given serious thought.

OR: Are you a believer in a cashless society and negative interest rates, like Kenneth Rogoff?

Summers: A cashless society would have a variety of benefits, from giving the Fed more room to operate to combatting crime. Perhaps in a century society will be cashless. But we are so far away from that point now that discussions of doing away with cash probably belong more to the realm of science fiction than to economics. It has been nearly 30 years since we started debating doing away with the penny. Society is so attached to even our smallest unit of cash that we continue to lose money on every penny minted. So a cashless society is something for the distant future.

OR: What are the big macroeconomic risks waiting in the wings?

Summers: There will be a next recession, probably relatively soon. The biggest risk is that monetary policy will not have enough room to act when that recession comes and that fiscal policymakers will be unwilling to act. The Fed should be focused on this more.

OR: What do you think about a movement from central bankers being lenders of last resort to being pawnbrokers for all seasons, as Sir Mervyn King conceives of it?

Summers: I am in favor of steps that make the banking system less fragile than it was pre-Crisis. But it is also important not to over-react in the opposite direction. Fundamentally changing the banking system’s ability to create money and credit would likely be such an overreaction.

OR: How do you assess Trump’s economic strategy so far?

Summers: Strategy might be too kind a word here. I have been and remain critical of President Trump’s agenda.

OR: Do you see NAFTA being scrapped? What would be the ramifications?

Summers: I hope not. Scrapping NAFTA would undermine relations with our neighbors while shifting demand from Mexico to China.

OR: Do you think stepping out of TPP was as major a missed opportunity as its supporters argue?

Summers: I do think it was a missed opportunity both economically and strategically.  China is aggressively building Sino-centric multilateral institutions and enlarging its sphere of influence in Asia. It is not a good time for the U.S. to be pulling back from trade in the region.

OR: You were involved in the bailout of Mexico during the Tequila Crisis. With a couple of decades of perspective, what is your general view of government bailouts? Is moral hazard a real issue?

Summers: Each crisis and bailout is different. But I think it is important to remember the paradox at the heart of many financial crises. They are brought about by too much greed and too little fear; too much spending and not enough saving; too much borrowing and not enough worrying. The proper response to crisis is more greed, more spending, and more borrowing. Those things usually will not happen spontaneously. They need government prompting.