Analysis: Summers-led Fed might raise rates faster than Yellen

WASHINGTON Sun Aug 18, 2013 6:05am EDT

Former U.S. Treasury Secretary Lawrence H. ''Larry'' Summers speaks during a financial and economic event at the London School of Economics (LSE) in London March 25, 2013. REUTERS/Jason Alden/POOL

Former U.S. Treasury Secretary Lawrence H. ''Larry'' Summers speaks during a financial and economic event at the London School of Economics (LSE) in London March 25, 2013.

Credit: Reuters/Jason Alden/POOL

WASHINGTON (Reuters) - Barring another financial crisis or slide back into recession, the next head of the Federal Reserve is likely to oversee a gradual normalization of monetary policy.

But that pace, including the first interest rate hike, might be somewhat quicker under former Treasury Secretary Lawrence Summers than under current Fed Vice Chair Janet Yellen, the two top contenders for the job, if their own comments are any guide.

Moreover, a Summers-led Fed would appear less likely to extend or expand the use of the extraordinary measures that the central bank has undertaken during the tenure of current chairman Ben Bernanke, whose term expires in January.

The distinction between Summers and Yellen is perhaps best illustrated by remarks they delivered at separate events in April.

Yellen, a strong supporter of Bernanke's policies, in a speech to business editors in Washington, exhorted the Fed to keep its focus on efforts to foster a lower unemployment rate, even if it comes at a cost of stronger-than-desired inflation.

By contrast, Summers, in a separate, closed event in California later that month, raised doubts that the unemployment rate could drop all that much lower without kindling unwanted levels of inflation.

He also was skeptical about how effective the Fed's massive bond buying program, known as quantitative easing, has been in promoting economic growth.

CONTINUITY

"Both Yellen and Summers are unlikely to commit the mistake of premature policy tightening, and that risk is probably somewhat lower with Yellen than Summers," said Michael Feroli, an economist with JP Morgan in New York.

That said, commitments the Fed has already undertaken make quick changes unlikely whoever gets the job, as St. Louis Fed President James Bullard noted on Thursday.

"I would expect a lot of continuity in policy, and I think any new person coming in would want that continuity. They don't want to come in and really rock the boat a lot. So I would expect a smooth transition," Bullard said in Louisville.

But slight differences in how the new Fed chair views policy could matter a great deal if the economy fails to recover as expected, or if there is a debate about how long to hold interest rates near zero once unemployment has fallen further.

The Bernanke-led Fed has already committed to keeping rates ultra-easy until unemployment hits 6.5 percent, and at least one official advocates lowering this forward guidance to 5.5 percent in order to hold down borrowing costs.

Summers might be less inclined to back such a move if the news on the economy continued to be mixed.

Yellen's strong support for the importance of driving down long-term unemployment, even if that meant inflation rising a bit, could be more open to such an aggressive move.

She has also laid out a so-called 'optimal policy path' that would permit a bit more inflation than the Fed's 2 percent goal in order to push down long-term unemployment, which she views as even more damaging to the nation's economic health.

As a result, there is a broad body of public written and spoken commentary in which she has articulated an approach which would not diverge much from the path already laid out by Bernanke, and might even be more dovish.

SUMMERS NO HAWK

In contrast, most of Summers' recent comments have been on fiscal policy, where his advocacy for government intervention might infer a readiness to maintain Fed stimulus.

But he has talked about monetary policy on at least two occasions in the last year, and these remarks make clear he is no hawk in the sense of the fierce Fed critics who blame the central bank's dramatic action for stoking a looming inflation.

Indeed, he argued in favor of additional quantitative easing in a Reuters opinion piece published on June 3, 2012.

"Many in both the U.S. and Europe are arguing for further quantitative easing to bring down longer-term interest rates. This may be appropriate given that there is a much greater danger from policy inaction to current economic weakness than of overreacting," he wrote.

And in his most comprehensive monetary policy remarks, at an April conference in Santa Monica, California, hosted by Drobny Global Advisors, he explicitly played down the dangers of inflation.

SKEPTIC

But he also voiced reservations about the benefits of further aggressive bond purchases, saying that "QE in my view is less efficacious for the real economy than most people suppose," according to a transcript of his comments obtained by Reuters.

That view could be significant if the economy fails to recover.

The Fed expects to scale back bond buying later this year and end the program by mid-2014. It may want to consider delaying that wind-down, or even increasing purchases from a current $85 billion monthly pace, if growth disappoints.

A Summers' Fed might resist extending the program from worry it will not have much benefit, but carries mounting costs, which he hinted at the April conference by pointing to signs that emerging market credit "is starting to look a little frothy."

That market subsequently has cooled substantially due to signals the Fed is nearing the point of reducing its purchases.

Furthermore, he has also signaled a gloomy view on how fast the economy can expand in the future without overheating, noting that the natural rate of unemployment may have risen and its potential rate of growth may have declined.

"To the extent that view is accepted, it should operate in the direction of leading one to expect the beginning of the tightening phase to happen sooner than is now supposed by many," Summers told the invitation-only event in Santa Monica.

That hint of doubt in his mind about how much slack might be left in the economy if the jobless rate reached 6.5 percent could translate into a readiness to raise interest rates faster once the threshold is breached.

"He might be more likely than Yellen to support raising the funds rate target soon after the 6.5 percent threshold is met," said Laurence Meyer at Macroeconomic Advisers.

"We suspect that Summers might be inclined to raise rates more quickly than Yellen after the first rate hike," the former Fed governor wrote in a client note.

(Reporting by Alister Bull; Editing by Leslie Gevirtz)

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
Comments (6)
Robertla wrote:
Quantative easing is program designed to continue a transfer of wealth to financial speculators…..if anything has been learned from the Great Depression, it would be how to put the burden on the lower and middle classes, while artificially buoying asset prices……….keeping wealthy people on an even keel.

Aug 18, 2013 8:46am EDT  --  Report as abuse
nose2066 wrote:
And if interest rates were increased, older folks living on fixed income interest would applaud.

For years, the financial community told older people that the “prudent” thing to do was to put the greatest part of their assets into fixed income. The Fed turned that advice on its head.

Apparently the prudent thing that older folks were supposed to do was to sit in front of their computer screens and attempt to anticipate and “front-run” the actions of the Fed.

And please notice that the Fed never talks about the “efficient allocation of capital” anymore. It’s a long forgotten concept.

Aug 18, 2013 10:04am EDT  --  Report as abuse
Jake987 wrote:
The posted comments here are right on so far. Bernanke killed interest income and forced retirees to spend principal the second shoe falling will be inflation at rates higher than interest doubling the rate of depleting 45 years of hard work and savings.

As a punishment for Ben, he should disgorge every penny he has made as a result of these policies and the son he put through med school with cheap student loans should be sentenced to work at McDonalds for 30 years.

Aug 18, 2013 10:45am EDT  --  Report as abuse
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.