Larry Summers and Federal Reserve Independence

Warning: This post is speculative. It contains my thoughts and concerns only. It is not economic analysis.

Larry Summers, one of the President’s chief economic advisors, gave a speech at Brookings today. The speech was mostly exactly what one would expect: lots of talk about how the administration’s bail out is going to work and a few assertions that it might already be working. We could go through these but you would not find my views surprising.

Two paragraphs in the introduction to the speech, however, are of note. Here is the first:

Economic downturns historically are of two types. Most of those in post-World War II-America have been a by-product of the Federal Reserve’s efforts to control rising inflation. But an alternative source of recession comes from the spontaneous correction of financial excesses: the bursting of bubbles, de-leveraging in the financial sector, declining asset values, reduced demand, and reduced employment.

Two causes of recessions? The Fed and bubbles bursting. You do not have to be a real business cycle economist to think there might, just might, be other reasons. For example, Hamilton seems certain that at least some of the 70’s and 80’s downturns were a result of oil shocks.

Ignore the bubbles part. Why is he saying that the Fed has caused the majority of the post-war recessions? Notice, he says this without any of the usual hedge words or qualifiers. He states it categorically as if it is fact. This is not an accident. It is the written text of a speech and the written text of speeches of White House officials is vetted. Even if Summers truly believes the statement, why put it in the speech.

Before I go on, here is the second paragraph.

Our single most important priority is bringing about economic recovery and ensuring that the next economic expansion, unlike it’s predecessors, is fundamentally sound and not driven by financial excess.

“unlike it’s predecessors” The phrase jumps out. Is he saying that all previous economic expansions have been fundamentally unsound and driven by financial excess? All of them? Or does he just mean the economic expansion since say 1987 when Greenspan took over the Fed?

He is very carefully and almost in so many words saying that not only does the Fed cause recessions but the periods where the Fed has seemed to shepherd the economy along robust expansion paths, are actually the precursors to bubbles, making the Fed responsible for all recessions.

Here is what I fear. (Let me emphasize again: this is not analysis it is just my own personal thoughts on the matter.) These statements are intended to subtly begin the process of undermining the Fed. I have a hunch the administration would like a Fed with even more expansionist views on monetary policy. Perhaps one that is a bit less independent and a bit more willing to print.

I hope I am misreading the statements: I don’t think I am. I will be watching Summers’ speeches a bit more closely from now on. This is a dangerous path they are walking.