The Fed doesn't have the wiggle room to cut interest rates as low as it hopes to, according to ex-Treasury Secretary Larry Summers.
The top economist issued a word of caution for investors hoping for steep rate cuts from the Fed.
In an interview with Bloomberg, Summers said central bankers have likely underestimated the so-called neutral rate, which is the level that neither expands nor contracts the economy.
Fed officials lowered interest rates 50 basis points at their last policy meeting in a shift from fighting inflation to supporting the labor market, and officials projected that the long-run Fed funds target rate would hover around 2.9%.
However, the neutral rate in the economy is likely closer to 4%, Summers estimated, meaning central bankers probably won't be able to take interest rates much lower without the risk of sparking a fresh bout of inflation.
"I don't think that it's likely that the neutral rate is as low as the Fed believes," Summers added. "We've had huge increases in wealth, vast changes in the budget deficit, in the level of the national debt. We've seen major new signs of increased investment in the green sector, in AI and in energy generation. And so you take all those pressures downwards on savings, upwards on investment, and I think the neutral real rate has gone up," he said.
That suggests monetary policy isn't as restrictive as markets or the Fed currently believes, which explains why the US economy has held up so well despite elevated rates, Summers added.
Though interest rates are at their highest levels since 2001, economic activity remains resilient, with GDP estimated to expand by 2.9% in the third quarter, per Atlanta Fed economists.
"I think the risks of actually going as far with monetary as the Fed seems to think that it will are pretty significant in terms of having an increase in inflation,' Summers added.
Other forecasters have warned of inflation risks remaining high, especially as the Fed embarks on its rate-cutting cycle. Inflation is likely to remain "sticky" and could "surprise the Fed again," BlackRock strategists said in a note this week, citing higher debt levels and other structural changes in the US economy.
