Summers: Fed could be making a dangerous mistake

Former Treasury Secretary Larry Summers.
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Former Treasury Secretary Larry Summers.

The U.S. Federal Reserve would make a "serious error" if it raised interest rates in the near future, according to Larry Summers, the former secretary of the U.S. Treasury.

Writing in the Financial Times, the economist and Harvard University professor said that tightening policy would risk inflation being lower than 2 percent -- the target set by policymakers at the U.S. central bank -- and threaten full employment levels.

"(It) will adversely affect employment levels because higher interest rates make holding on to cash more attractive than investing it. Higher interest rates will also increase the value of the dollar, making U.S. producers less competitive and pressuring the economies of our trading partners," he wrote.

"The Fed does not have to do the job. At this moment of fragility, raising rates risks tipping some part of the financial system into crisis, with unpredictable and dangerous results."

This might not be the first time that Summers has expressed such views, but his article comes just a few weeks head of the next policy meeting by the Fed, one of the most closely-watched for years, as some analysts predict that rates could move off their current record lows.

It also comes amid a market selloff that has seen the Dow and Nasdaq slide into correction territory. The major averages posted their worst week in four years last week amid global growth concerns and serious instability in Chinese stock markets. The Shanghai Compositeplunged over 8 percent -- its biggest one-day percentage fall since February 27, 2007.

Summers argued that the outlook for the Chinese economy was "clouded at best", adding that markets themselves were dampening any euphoria or overconfidence they had seen earlier in the year.

It is no longer plausible to blame "temporary headwinds" that require low interest rates, he said, reiterating his long-held belief that the world was now facing a potential "secular stagnation" - where a lack of investment in a developed economy leads to falling incomes and stagnant demand.

Summers believes that continued satisfactory growth requires sticking with low interest rates.

"New conditions require new policies," he said.

"There is much that should be done, such as steps to promote public and private investment so as to raise the level of real interest rates consistent with full employment. Unless these new policies are implemented, inflation sharply accelerates, or euphoria in markets breaks out, there is no case for the Fed to adjust policy interest rates."