Why Is the Fed Seeking Advice From the Architect of Past Financial Meltdowns?

As the leader of a body that determines the fate of the world behind closed doors, the head of the Federal Reserve is highly scrutinized. Observers, for example, used to guess what former Fed Chair Alan Greenspan was thinking about interest rates based on the weight of his briefcase. If the load was heavy, the reasoning stood, Greenspan had paperwork to convince the other members on the panel that sets interest rates, the so-called Federal Open Market Committee (FOMC), to vote to cheapen the cost of borrowing in United States dollars, thereby signaling better times ahead for the U.S. economy and labor market.

Since the Great Recession, the Fed has encouraged observers to abandon pseudoscientific briefcase analysis by striving to make its own inner workings more transparent. For example, it now releases minutes and forecasts from its eight annual meetings, with the Fed chair staging press conferences afterward.

But the FOMC has a tradition of discouraging dissenting votes. The committee’s statements and forecasts are still, therefore, combed over by observers looking for minor edits and discrepancies from the pronouncements of one conclave to the next — to divine the thought process of FOMC members and their influential chair who, collectively, can put vast sums of people out of work with minor nominal additions to the so-called federal funds rate.

In recent years, this forensic verbal analysis has played a role in the public debate over inflation, which the Fed is tasked, by law, with controlling. The FOMC’s use of the adjective “transitory” to describe price growth throughout 2021 was seized upon by critics to accuse Fed Chair Jerome Powell of lacking the will to increase interest rates because he lacked the stomach to deal with unemployment spikes that typically follow such hikes — which some say he should lack, given that Congress gave the Fed a dual mandate, keeping a lid on both inflation and unemployment.

The most prominent of these critics was a controversial figure in his own right: former Treasury Secretary Lawrence “Larry” Summers. In November 2021, Summers penned an op-ed for The Washington Post blasting the Fed for concluding that elevated price growth was caused by temporary supply chain problems triggered by the COVID-19 pandemic. In Summers’s view, the culprit was the $1.9 trillion fiscal stimulus legislation signed into law by President Joe Biden in March 2021, which helped prime the labor market to give workers a degree of leverage over employers that they had not enjoyed in decades, leading to wage increases.

Not long after the publication of the column, Summers was rocketed to the forefront of the debate, when Powell announced that the FOMC would stop using the word “transitory” to describe inflation. In December of that year, Summers used his renewed prominence to accuse the Fed of failing to go far enough, in another Post op-ed castigating the body for telegraphing insufficient future interest rate hikes.

“There have been few, if any, instances in which inflation has been successfully stabilized without recession,” Summers wrote. He would later put a price tag on the cost of achieving such stability: 5 percent unemployment for five years, or 10 percent unemployment for one year. Either way, millions of people in the U.S. would need to lose their jobs for a sustained period of time.

The op-eds are noteworthy, in hindsight, because the FOMC, with its cloistered intrigue, essentially adopted Summers’s view, despite its mandate to pursue maximum employment. The writings are also noteworthy because Powell personally received the text of the published articles from Summers via email, according to records of the Fed chair’s emails from 2021 released to the author under the Freedom of Information Act (FOIA).

The Fed denied that the records indicate any special reverence for Summers on Powell’s behalf. When asked if the chair has subscriptions to alerts for commentary publications by other monetary policy analysts, Emma Jones, a representative for the Fed, offered a clarification: Powell never signed up for the alerts from Summers in the first place. Jones directed Truthout to contact the former treasury secretary. A representative for Summers speaking on background confirmed, noting that Summers emails the text of his Washington Post columns to all contacts in his address book.

But the Fed didn’t have a direct response to questions related to email records that it declined to release: 27 pages of records were withheld by the central bank, citing one exemption to FOIA protecting the personal privacy of officials and another protecting policy deliberation before final decisions are reached, the so-called deliberative process exemption.

When asked about the names or the number of other commentators who have impacted policy deliberations, Jones pointed to Powell’s public schedule to show the numerous people that he meets on a daily basis, and to a November 2022 public appearance in which Powell discusses being an avid reader of newspapers every morning. Previous reporting and commentary has indicated that the Fed chair has special respect for The Wall Street Journal, as evidenced by the Fed’s use of the paper’s chief economics correspondent, Nick Timiraos, to publicly disseminate news ahead of official announcements.

But if Powell and other FOMC members haven’t been closely following Summers’s commentary, observers could be fooled by the numbers. Since December 2021, the FOMC has raised the federal funds rate to 5 percent from 0.08 percent, with more increases expected, a level consistent with Summers’s advice in his March 2022 column.

“With inflation running above 3 percent, this means rates of 5 percent or more — something markets currently regard as almost unimaginable,” Summers wrote then. The Fed had previously forecast an increase in the federal funds rate of only 0.75 percentage points over the next year, a magnitude dismissed by Summers as inadequate in the December 2021 column that found its way to the Fed chair’s inbox.

“You might point out in your piece that since early 2022 the Fed has acted largely in line with his advice,” Summers’s representative noted. In August that year, the former treasury secretary praised Powell for being willing to accept the “short-term adverse consequences” of tightening the money supply.

To left-of-center skeptics of Powell, the convergence is worrisome. Powell and Summers say that rate hikes are necessary to curb unemployment in the long run. But critics say that the labor market isn’t to blame for inflation, and that rate hikes make mass unemployment practically inevitable.

“As I see it, if Jay Powell does what Larry wants and Larry is wrong, we are then in a definite pickle,” Brad DeLong, an economic adviser to President Bill Clinton told The New Yorker, in an April 2022 profile of Summers.

There are also those who argue that rate hikes are needlessly cruel because price growth is being driven by corporate monopoly power, which won’t be broken by tighter credit markets, but can be weakened by dissolving monopolies and oligopolies, and by imposing windfall taxes on corporate profits.

Summers has derided such views on monopoly power as “hipster antitrust” and has called the windfall profit tax “dangerous nonsense,” comparing the latter to former President Donald Trump urging people to drink bleach to protect themselves from COVID-19. Large dominant firms and incentives to gain market share, Summers argues, can bring price advantages to consumers.

But there is mounting evidence, including from research published by the Federal Reserve Bank of Boston, that market power is much more concentrated now than it was even two decades ago, just before the 2008 financial crisis, and that companies use their newfound power to pass a greater percentage of supply shock costs onto consumers.

Numerous corporate executives have also gone on the record in recent earnings calls to say that they’ve been able to make record profits, despite higher labor costs, because they simply raise prices. Inflation-adjusted wages also fell consistently from the middle of 2020-2022, and have mostly flatlined since the third quarter of last year.

Policymakers should therefore look at tools outside of the Fed’s purview, like those mocked by Summers, and other regulatory mechanisms including “targeted price controls and tighter enforcement of speculation on commodities futures markets,” according to Robert Pollin, professor of economics and co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts-Amherst.

“Still more infrastructure investments can serve to loosen supply-chain bottlenecks in the short run while raising productivity over the longer term,” Pollin told Truthout. He added that ratcheting up the green energy transition would “reduce dependency on volatile fossil fuel markets” like those that produced record prices after Russia’s invasion of Ukraine in February 2022.

“All of these alternatives to contractionary monetary policies offer the critical advantage that they can reduce inflationary pressures without forcing up unemployment rates,” Pollin said.

As far as Fed policy is concerned, Pollin pointed to PERI research which shows that the central bank’s 2 percent inflation target sacrifices price-adjusted economic growth to “weaken workers’ bargaining power.” The public could be better served by inflation targets between 4-5 percent, the research argues.

“There is, in my opinion, nothing wrong in principle with Powell or anybody else at the Fed consulting Summers or any other economist,” Pollin said. “The problem, rather, is much more fundamental: that what Summers and others like him are arguing is just wrong in the very specific sense that it is without a foundation in research.”

Summers’s theory of inflation has also attracted significant criticism for its focus on U.S. economic stimulus. Price growth since 2021 has been global, striking countries independent of their government spending. In The New Yorker’s recent profile, the ex-treasury secretary defended his analysis by pointing to research published by the San Francisco Fed attributing 3 percent price growth in the fourth quarter of 2021 to government “income transfers.” But that would only account for about half of inflation at the time. Inflation in Eurozone countries has been about as bad as inflation in the U.S. despite the lack of similar fiscal stimulus.

Recent developments in financial markets have brought the spotlight on Powell’s judgment, namely the fact that two of the three largest bank failures in U.S. history have happened since March. A report published in late April by the Fed itself on the third-largest collapse, the failure of Silicon Valley Bank, said the firm was able to recklessly expand, in part, because of the regulatory rollback overseen by Powell under the Trump administration, prompted by legislation passed by Congress with the support of Republicans and right-leaning Democrats.

The report’s criticism was most scathing when detailing the role of Randal Quarles, the Fed’s vice chair of supervision during the Trump administration. Powell endorsed Quarles’s zeal for deregulation at the time, which isn’t surprising considering the pair have a professional relationship going back decades, in both the public and private sector, and have been seemingly inseparable at times.

In addition to their joint stint at the Fed under Trump, Powell and Summers have worked together at the Treasury Department during the George H.W. Bush administration, and at two separate private sector ventures: the Carlyle Group, a high profile well-connected private equity firm, and the corporate Manhattan-based law firm Davis Polk & Wardwell. “Powell recruited Quarles to work with him at the Treasury Department in the early 1990s and recommended him to Trump for the Fed post,” a recent Foreign Policy article noted.

The latter pick was criticized at the time by the top Democrat on the Senate Banking Committee, Sherrod Brown (D-Ohio), who noted that in 2006, while serving as a financial regulator at the Treasury Department, Quarles praised the banking industry as “strong,” “healthy” and “well-capitalized.” Shortly after, the subprime mortgage crisis in the U.S. brought the entire global economy to a standstill.

It would be an understatement to say that Summers’s record has similar red flags. As President Clinton’s treasury secretary, Summers helped lead the bipartisan push for deregulation, which set the stage for the frenzied Wall Street risk-taking that caused the financial meltdown in 2008. Beforehand, as Clinton’s treasury undersecretary for international affairs, Summers helped lead the U.S. contingency that assisted Russia in its disastrous privatization process after the collapse of the Soviet Union, which led to the establishment of an oligarchy on one end of the income distribution and mass death on the other.

Summers’s record since the Clinton years doesn’t cover itself in glory, either. His stint as an adviser to President Barack Obama was marred by his support for weak stimulus, based on an overly optimistic forecast of growth. Years of income stagnation followed. In recent months, Summers has been criticized for his work promoting a cryptocurrency firm called Digital Currency Group, and then for evidently attempting to conceal his involvement in the company in the run-up to its bankruptcy filing in January. And Summers’s stint as president of Harvard infamously ended in disgrace after he claimed that women lacked the mental capacity to excel in math and science. (The ex-treasury secretary’s representative was asked for an opportunity to respond to the cryptocurrency criticism, as Summers has publicly defended most other controversial aspects of his record but did not respond by the time of publication.)

In some ways, Summers’s recent commentary on the Fed hearkens back to the unceremonious end of his Harvard presidency. In October 2021, before he and Powell began to see eye-to-eye, Summers said: “We have a generation of central bankers who are defining themselves by their wokeness,” echoing criticism of the Fed made by Republican lawmakers upset with the agency’s consideration of social issues when formulating economic policy, and its refusal to cast aside its employment mandate in pursuit of price stability. Summers would later tell The New York Times that there’s no problem with the Fed considering issues like racism and inequality; he was attempting to accuse the agency of losing “some of the rigor” that informs its policymaking.

Months before the jibe, in April 2021, Powell had spoken to the press about his concern for people living in parks and under freeways near the headquarters of the Federal Reserve in Northwest Washington, D.C. Research indicates that the population of such encampments will likely grow over the coming years, as the impact of recent interest rate hikes becomes fully felt in the labor market.