Investors who love QE should fear Larry Summers

In speeches, editorials, and recent studies, Summers, who has emerged as a top choice to be the next Fed head, has regularly questioned the wisdom of the U.S. central bank’s signature bond buying program to stimulate the economy. Summers has said quantitative easing, which is meant to lower interest rates, has done less to boost the economy than people think, and he has frequently brought up the program’s potential downsides.

At a breakfast hosted by the Wall Street Journal last month, Summers raised the possibility that quantitative easing was creating a bubble and perhaps adding to the nation’s problems with income inequality. “There’s certainly anecdotal evidence of yield chasing by investors who are seeking to earn greater than completely safe rates of return,” said Summers. “To what extent that reflects desirable increases … and what extent that reflects movements towards bubbles is a judgement that … monetary policy authorities will have to make over time.”

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Summers has also dismissed concerns brought up by Warren Buffett and others that ending QE could shock the markets. In April 2011, at a gathering of economists, Summers said the idea that there would be a big jump in interest rates when the Fed pulls back from the bond market was silly. “Some acquaintance with efficient-market-type notions would lead one to be rather skeptical of that idea,” said Summers at the time. In fact, interest rates have risen sharply in the past two months following suggestions by Ben Bernanke that the Fed would soon wind down its quantitative easing program.

At that same conference, Summers said there were questions about the Fed “exploring multiple instruments” to lower interest rates. For Summers, those questions have persisted. In an editorial for Reuters last summer, Summers wrote, “There is an oddity in this renewed emphasis on quantitative easing.”

He said that the slightly lower interest rates that could be generated by more bond buying from the Fed was unlikely to compel business to increase borrowing or make new investments. At a hedge fund conference in April, according to the Financial Times, Summers said his verdict on QE was basically, “meh.” Not much of a help, but not much of a hurt either. “If QE won’t have a large effect on demand, it will not have a large effect on inflation either,” he reportedly said.

One of Bernanke’s main justifications for QE is something called the wealth effect. Summers isn’t buying that either. He says just because the stock market is higher doesn’t mean people will spend more. Summers has argued what really boosts spending is higher incomes and, if anything, because of lowered interest rates, QE has lowered incomes, not raised them.

Indeed, if Summers had been Fed chair five years ago, quantitative easing might never have occurred. In September 2008, in an editorial in the Washington Post, Summers suggested that Bernanke might as well pack up his bags and go home. With interest rates already so low, Summers said there was little else the Fed could do to boost the economy. Since then, the Fed has bought $2.3 trillion in Treasury and mortgage bonds. Long-term interest rates, as measured by 10-year government bonds, fell to 1.4% last summer, from 3.6% in September 2008, but have recently rebounded to nearly 2.6%.

Summers, though, hasn’t always been solidly against QE. Back in October 2011, he wrote it might be a good idea for the Fed to step up its purchases of mortgage bonds. But that was in the context of how to save the housing market. Now that real estate prices are recovering, it’s unclear if Summers would support further purchases.

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Here’s the thing we don’t know: How much of Summers’ criticism of QE has actually been about QE. Summers has regularly argued that the federal government should be borrowing more money to put toward infrastructure and other projects. Saying that the Fed and its policies have limited potential to boost the economy, and real downsides, strengthens Summers’ argument for more spending. And, indeed, Bernanke too, at times, has advocated for more spending.

But in the absence of more cash to spend from Washington, Bernanke has pushed forward with QE anyway. And while Bernanke has said we might be nearing the end of the bond buying program, he committed to continuing QE as long as unemployment remains high. If Summers believes anything he has said in the past five years, why would he.