With inflation and inflation expectations below target and declining, there would be little case for preemption even if inflation above target was a serious problem. But as we have seen, there are strong reasons for thinking that the Fed should, to be consistent with its mandate, let inflation rise above 2 percent.
Fourth, as I have stressed in my writings on secular stagnation and in a recent conversation with David Wessel, there is good reason to believe that a given level of rates is much less expansionary than it used to be given the structural forces operating to raise saving propensities and reduce investment propensities.
I am not sure that a 2 percent funds rate is especially expansionary in the current environment. And I am confident that if the Fed errs and tips the economy into recession, the consequences will be very serious given that the zero (or perhaps slightly negative) lower bound on interest rates will not allow the normal countercyclical response. This too counsels a bias toward expansion.
Fifth, a “whites of their eyes” paradigm does not require the Fed to abandon its connection to price stability. It simply needs to assert that its objective is to assure that inflation averages 2 percent over long periods of time. Then it needs to acknowledge that although inflation is persistent, it is very difficult to forecast and signal that it will focus on inflation and inflation expectations data rather than measures of output and employment in forecasting inflation.
With these principles internalized, the Fed would lower its interest-rate forecasts to those of the market and be more credible. It would allow inflation to get closer to target and give employment and output more room to run.
Commentary by Larry Summers, the former Treasury Secretary and currently the Charles W. Eliot University Professor and President Emeritus at Harvard University. Follow him on Twitter @
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