After the Federal Reserve opened its easing cycle with a "radical magnitude" of 50 basis points last week, many investors hope that there will be such "good news" in the future. But former US Treasury Secretary Lawrence Summers said that the Federal Reserve may not be able to cut interest rates as it wishes.
He believes that the Federal Reserve does not have room to lower interest rates to a low level. Summers stated in a recent interview that Federal Reserve officials may have underestimated the so-called neutral interest rate (a level that neither stimulates nor limits). Previously, he also criticized the Federal Reserve, stating that the bank's understanding of the neutral policy rate was flawed, which could lead to erroneous judgments about its monetary policy.
If you don't know what neutrality is, you don't know if you're expanding or limiting, "he explained at the time.
Although the median long-term expectation for the benchmark interest rate announced last week was raised from 2.8% to 2.9%, Summers estimates that the "more realistic" neutral interest rate may be closer to 4%, which means that Fed officials may not be able to significantly lower interest rates without triggering a new round of inflation risks.
In his latest interview, he said, "I don't think the neutral interest rate is likely to be as low as the Federal Reserve thinks
"Our wealth has increased significantly, the budget deficit and the level of treasury bond have changed dramatically. We have seen significant new signs of increased investment in the green field, artificial intelligence and energy production. Therefore, considering the pressure of falling savings and rising investment, I think the neutral real interest rate has risen." He added.
Summers also stated that this indicates that monetary policy is not as restrictive as the market or the Federal Reserve currently believes, which explains why the US economy remains strong despite rising interest rates.
Despite interest rates being at their highest level since 2001, US economic activity remains resilient, with economists at the Federal Reserve Bank of Atlanta estimating that GDP will grow by 2.9% in the third quarter. Therefore, Summers believes that if the Federal Reserve takes such aggressive interest rate cuts as expected, there is a significant risk of further inflationary pressures.
Other forecasters have also warned that inflation risks remain high, especially as the Federal Reserve begins its interest rate cutting cycle. BlackRock strategists stated in a report this week that inflation may remain "sticky" and may "surprise the Federal Reserve again" due to rising debt levels and other structural changes in the US economy.