It was supposed to be a fait accompli. Janet Yellen was going to be the next Fed Chair, and anyone who said otherwise was some combination of trolling, wrong, and wrong. Betting markets certainly thought so: Yellen started out as a 1-to-5 favorite to get the gig. But a not-so-funny thing happened on the way to our first female Fed Chair -- Ezra Klein reports that Larry Summers is actually the frontrunner for the job now.
It's not an easy question to answer. It's not that Summers isn't a brilliant economist -- he most certainly is -- but rather that he doesn't have, well, any of Yellen's central banking expertise. She's spent much of the past 20 years at the Fed. He's barely said anything about monetary policy. Now, he might be as good as we know she would be, but that's the thing: We know she would be good. Very, very good.
After serving as a Fed governor from 1994 to 1997, as president of the San Francisco Fed from 2004 to 2010, and as Fed Vice-Chair for the past three years, Yellen has emerged as one of the central bank's intellectual leaders. She talked Alan Greenspan out of targeting zero percent inflation, because it would have increased the odds of falling into a liquidity trap (like we have now), back in 1996. She was one of the first to warn about the risk of the shadow banking blowup and housing slump setting off a credit crunch back in 2007. And she's been one of the architects of the Fed's unconventional policies today.
It hasn't gotten a lot of attention, but Yellen is something of a quiet revolutionary. Now, I prefer Christina Romer's approach of, if not yelling, at least speaking loudly from the rooftops that the Fed needs to do more (it's a scandal that she hasn't gotten real consideration for Fed Chair). But Yellen has cautiously moved the Fed in that direction. As Cardiff Garcia of FT Alphaville points out, her idea of "optimal control" policy looks an awful lot like NGDP targeting. In plain English, she thinks the Fed should let inflation go higher than it likes for a little while to bring unemployment down faster. Not that this is a new idea for her. It's what she said the Fed should do at a policy meeting in 1995 (page 43):
Fortunately, the goals of price stability and output stability are often in harmony, but when the goals conflict and it comes to calling for tough trade-offs, to me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target.
As a colleague noted, she was all but endorsing NGDP targeting, which she then agreed was a "sensible rule." And it's even more sensible when interest rates are at zero.
It isn't clear what Larry Summers actually thinks about monetary policy. He probably wants to keep rates low for a long time, but that's about all we know. He hasn't been a central banker. And he hasn't written much about it. But the few things he has said aren't encouraging. For one, he doesn't think much of quantitative easing. As Robin Harding of the Financial Times reports, Summers recently said that he thinks "QE is less efficacious for the real economy than most people suppose." But more than that, Summers seems to share the Wall Street view that more bond-buying might just risk another bubble or mal-investment -- at least that's what he suggested a year ago:
Many in both the U.S. and Europe are arguing for further quantitative easing to bring down longer-term interest rates. This may be appropriate given that there is a much greater danger from policy inaction to current economic weakness than to overreacting.
However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to undertake with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative real interest rate. There is also the question of whether extremely low safe real interest rates promote bubbles of various kinds.
In other words, he thinks the Fed pushing down real interest rates might only push companies to make bad investments they otherwise wouldn't make. It's a very Austrian view of things -- the idea that pushing interest rates "artificially" low makes businesses make mistakes.
This is not good. Now, there are plenty of people who think QE is going to turn us into Zimbabwe or inflate the mother-of-all-bubbles or just bail out the banks, but none of those people should be running the Fed. The reality is QE has been a net positive, though it's not clear how much. For one, as Paul Krugman points out, the Fed's bond-buying signals that the Fed really doesn't intend to raise rates anytime soon. Of course, the Fed has said it won't anyways, but there's nothing to stop it from going back on its word if inflation ticks up. QE makes this promise to be irresponsible more credible.That's clear enough from the way interest rates and expectations of future interest rates jumped after the Fed said it might soon slow the pace of its bond-buying. For another, QE has reduced our indebtedness. Now, it's true that QE shortens the maturity of our debt -- a point Summers has worried about -- but the way it pushes down interest rates and pushes up growth are fiscal pluses. Joseph Gagnon, a senior fellow at the Peterson Institute and a former Fed official, estimates that QE might have reduced our debt-to-GDP ratio by 12 percentage points the past four years.
Monetary policy isn't exactly the sexiest topic, but the next Fed Chair is the most important economic decision Obama will make for the rest of his term. Whoever it is will face the tricky task of eventually exiting the Fed's unconventional policies without losing the recovery. The question is how eventual that eventually will be. Now, even with core inflation at an all-time low, there's a growing chorus calling on the Fed to tighten, and tighten now, to head off a potential bubble. We know Janet Yellen would ignore them, and focus on jobs.
Would somebody else focus even more on jobs? I've already said I think Christina Romer would be better, because she's more likely to fight to do more than the consensus-building Yellen -- which is the same argument for Summers. His infamous disregard for social niceties might make him more likely to push the committee in a more aggressive direction. But there's no evidence he would want to. His almost certainly strategic silence on most matters Fed-related means there aren't many tea leaves to read. But the ones we can read suggest he isn't quite as dovish as Yellen. And he might even buy into the bubble fears. That should be more than enough to disqualify him against someone who clearly has the right ideas and the right experience.
And besides, consensus-building might be underrated. Fed Chairs come and go, but the Fed is forever. (Sorry, Ron Paul). Getting the rest of the committee on board with a decision makes that decision more durable -- which makes it more credible, too. In other words, trying to browbeat the rest of the Fed into doing something might backfire. Yellen's familiarity with the rest of the committee could just as easily make her more likely to (quietly) cajole them in a more aggressive direction than anyone else could.
Of course, it doesn't hurt that Yellen would be a history-making pick as the first female Fed Chair. But that has nothing to do with why she should get the job. She should get the job, because she's the best person for it out of all the contenders.
Sometimes, things are simple.
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