Former US Treasury Secretary Lawrence Summers stated that at some point, the Federal Reserve will have to intervene in the US government's continuously accumulating debt, as it has an impact on interest rates.
Summers said, "I understand that the Federal Reserve's job is not to intervene in fiscal policy, but I believe that over time, as the decision-maker of national monetary policy, the Federal Reserve will have to be involved in some of the issues related to Treasury debt
Summers said, "If debt increases and deficits rise, it means more demand in the economy. This will raise current neutral interest rates and further increase expected future neutral interest rates
Concerns about the US fiscal situation have led to a surge in US bond yields, which has surprised policymakers and prompted them to consider delaying further interest rate hikes. The total outstanding debt of the United States exceeds $33.5 trillion.
On the day before Summers' speech, Federal Reserve Chairman Powell stated that neutral interest rates may rise in the short term, but it is difficult to know exactly how much they will be in five years. Neutral interest rate, also known as R star, refers to the level of interest rate at which monetary policy neither stimulates nor limits the economy.
Federal Reserve decision-makers estimated a neutral interest rate of 2.5% in their September forecast. Summers believes that the actual neutral interest rate is between 3.5% and 4%.
Debt effect
Summers said, "When you try to sell a large amount of long-term debt due to a very large deficit, its price will fall, which means that the long-term yield will rise, and the term premium will rise." Term premium refers to the compensation that investors demand for taking on the risk of interest rate fluctuations during the bond term.
Summers stated that the widening fiscal gap has pushed up neutral interest rates, which means that the Federal Reserve must "raise real interest rates to maintain the same level of balance between throttle and brake. The rise in interest rates and term premiums "has a restraining effect on the economy
Summers stated that at some point, the Federal Reserve will have to intervene in fiscal policy.
He said this "may replace the brakes that the Federal Reserve had to provide, so it is not enough for the Federal Reserve to only recognize that interest rates are rising, it must implicitly form a view of what the reason is
The former Secretary of the Treasury has not yet seen evidence of insufficient liquidity in the US treasury bond bond market, but said that the Federal Reserve, especially the New York Federal Reserve Bank, which is responsible for supervising and supporting the market function, should "pay more attention to ensuring the good operation of the financial market, perhaps with less analytical statements on neutral interest rates. I think this will help the system perform its functions."