Larry Summers: Fed Shouldn't Raise Rates 'Until it Sees Whites of Inflation's Eyes'

When will the Federal Reserve know it's safe to increase interest rates?

"It should not raise rates until there is clear evidence that inflation, and inflation expectations, are in danger of exceeding its 2 percent target," former Treasury Secretary Larry Summers writes in the Financial Times.

The Fed's favored inflation measure rose only 0.7 percent last year.

Summers, now a Harvard professor, offers four justifications for his argument.

• "First, real wages for most workers have been stagnant.
• "Second, if inflation were to accelerate a bit this would be a good thing.
• "Third, a plane that accelerates too rapidly as it takes off may cause passengers discomfort while a plane that accelerates too slowly may crash at the end of the runway.
• "Fourth, the U.S. has never been more intertwined with the global economy."

Economists' consensus is that the Fed will begin raising rates around mid-year, and Summers says "inflation indicators might justify a rate increase before long."

But, he says, "the Fed could inject much needed confidence in the economy today and minimize future risks by announcing and following a strategy of not raising rates until it sees the whites of inflation’s eyes."

Summers probably won't be happy to hear the forecast of Byron Wien, senior adviser to Blackstone, who thinks the Fed will probably move in the first quarter.

"Many believe this is unlikely because Europe is near or in a recession and Japan is suffering as well," Wien writes in Barron's.

"They reason that increased rates will only make the dollar stronger and hurt our trading partners." They also point to sluggish wage growth—1.7 percent in 2014.

"My view is that the Fed is most responsive to domestic data: the U.S. economy [grew] 5 percent real during the [second and third] quarters, unemployment has dropped below 6 percent, and wages are starting to increase," Wien says.

Interestingly enough, his view on inflation doesn't seem too far from Summers'. "Inflation is not currently a problem, [so] the increase in rates is likely to be small and more an indication of a change in policy focus than a vigorous attempt to slow down an overheating economy," Wien writes.

Related Stories:

• Plosser: Fed 'Will Struggle' With Its March Policy Statement
• Boockvar: 'Fed's Game of Zero Interest Rates Has No Touch With Reality'