For decades, you could always count on the Federal Reserve to pull the plug on prosperity too soon, seeing ghosts of inflation everywhere. The Fed, responsive as it was to creditors, preferred a dose of recession to any sort of price pressures, especially wage increases.
That changed with the regimes of Fed chairmen Alan Greenspan and Ben Bernanke.
Greenspan was willing to keep interest rates low because the banks kept getting into difficulty after bouts of speculative excess in the 1980s and '90s and needed the cheap money to rebuild their balance sheets. The ultimate such collapse occurred just five years ago this week, when the crash of Lehman Brothers revealed the rot in the entire system, and one over-leveraged domino after another fell.
Greenspan's successor, Ben Bernanke, kept the cheap money policy, but combined it with a dose of salutary regulation. Now, however, the usual suspects are issuing the usual warnings about the dangers of inflation. The word has been passed, and Fed is expected to begin pulling back on its heroic program of bond purchases (otherwise known as printing money) any month now.
The Fed, after a somewhat anomalous run as the engine of recovery, seems to be reverting to type.
Trouble is, the economy won't cooperate with this scenario. Inflation is nowhere to be seen, and the recovery continues to be weak.
The latest jobs numbers are just dismal. In August, the measured unemployment rate ticked down one-tenth of one percent to 7.3 percent, but only because more and more people are dropping out of the labor force since looking for work is futile. The percentage of adults in the labor force is at its lowest level since the 1970s, a period when most married women with children still stayed home.
Only one demographic group increased its rate of labor force participation -- people over 65, because they can't afford to retire. Even the rate of people over 70 is increasing, as the retirement system collapses.
Until now, Chairman Bernanke has had the votes to continue his program of bond purchases and cheap money. But the center of gravity on the Fed's policy-setting Open Market Committee is gradually shifting to the inflation hawks.
The financial press is convinced that the Fed will begin "tapering" (cutting back) its bond purchases as early as its next meeting. Interest rates have already risen in expectations of the Fed's policy shift.
The hawks are wrong. In the face of a feeble recovery, the Fed should be keeping interest rates extremely low. But it needs to combine loose money with tight regulation, so that the easy money doesn't induce financial speculation as it did last time.
There is historic precedent for this. In the well-regulated financial economy of the postwar boom, the Fed kept interest rates so low that they were effectively negative when adjusted for inflation. But because there were so few opportunities for financial speculation, the low interest rates translated to cheap capital costs for the real economy. It was an era of robust growth, broad prosperity, and a terrible time to be in the bond market. But what was bad for the bond market was good for everyone else (maybe there's a lesson there?)
Today, however, we are a long way from effective financial regulation. The the Dodd-Frank Act is more loophole than law, and five years after the crash the same business model that produced the collapse lives on.
Which brings us to the final act of the drama of Larry Summers versus Janet Yellen, soon to be resolved by President Obama (or perhaps, if Obama appoints Summers to chair the Fed, it could be resolved by the US Senate.)
Summers is more the inflation hawk of the two. He is also more of a light regulation man. If he gets the job, the Fed is likely to pull back from its low interest rate policy, with little improvement in the regulatory process.
Yellen, by contrast, has spoken out on the need for the Fed to keep doing what's necessary to stimulate a stronger recovery, and to offset the easy money with tough regulation. Wall Street, not surprisingly, prefers Summers. If Summers does get the job, it will be proof positive that the Fed as servant of the bond market is reverting to type.
Robert Kuttner's new book is Debtors' Prison: The Politics of Austerity Versus Possibility. He is co-editor of The American Prospect and a senior Fellow at Demos.