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2013-09-05 05:12:24
Style more than substance divides the two main candidates to head the Fed
Aug 31st 2013 | WASHINGTON, DC |From the print edition
IN A few weeks Barack Obama is expected to name a successor to Ben Bernanke,
whose term as Federal Reserve chairman ends in January. With any luck the next
chairman s tenure will be duller than Mr Bernanke s but that seems unlikely if
the succession race is anything to go by.
The two leading candidates are Larry Summers, Mr Obama s principal economic
adviser from 2008 to 2010, and Janet Yellen, currently the Fed s vice-chairman.
Supporters of both have gleefully highlighted their differences, but their
similarities are more striking. Both are highly regarded academic economists
who spent the first part of their career advancing understanding of
macroeconomic policy, and the latter part implementing it in Democratic
administrations.
Ms Yellen s supervisor at Yale was James Tobin, a future Nobel prizewinner. Her
initial research was on international development but she made her mark
studying labour markets. The theory of the efficiency wage , developed with
her husband and future Nobel laureate George Akerlof, posited that workers who
felt poorly paid were less productive. Knowing this, employers would pay them
more than the market-clearing wage, which would raise unemployment. Ms Yellen
and Mr Akerlof also demonstrated how firms and individuals might rationally
decline to adjust wages or prices in response to a monetary shock, and that
collective behaviour would produce recessions. By setting Keynesian
macroeconomic theory upon microeconomic foundations, this work helped build the
New Keynesian paradigm, which is how most central banks still view the world.
She worked at the Fed as a staff economist in the late 1970s, then returned as
a governor from 1994 to 1997, when she argued both for higher and lower
interest rates as her views on the risks of inflation evolved. She came back to
the Fed as president of its San Francisco bank in 2004, before being elevated
by Mr Obama to Fed vice-chairman in 2010.
Ms Yellen has little experience of financial markets and crises, though
recently she has immersed herself in financial-stability oversight. At times
she has publicly advocated a more dovish policy than Mr Bernanke. In two
speeches last year she used contemporary monetary theory to justify keeping
interest rates near zero for longer than the Fed then contemplated though this
would bump up inflation. The Fed has since moved to her position.
Like Ms Yellen, Mr Summers has spent his life steeped in academic economics.
Both his parents were economists, and two uncles, Paul Samuelson and Kenneth
Arrow, became Nobel laureates. His early research was prolific, spanning public
finance, capital markets, business cycles and labour markets. Some of his
biggest contributions overlap with Ms Yellen s. In a 1991 article he argued
that moderate inflation was better than zero because it made negative real
interest rates possible and real wage cuts easier. Ms Yellen would make the
same argument five years later inside the Fed, and that is why the Fed today
targets 2% inflation. Mr Summers also helped demonstrate how macroeconomic
policy, by mitigating financial crises and depressions, could permanently raise
output. That provides theoretical justification for the Fed s dual mandate of
stable prices and maximum employment.
To QE or not to QE
Mr Summers has never been a central banker and has been largely absent from the
debates on quantitative easing (or QE, the purchase of bonds with newly created
money) and forward guidance (eg, committing to keep interest rates at zero
until various criteria are met). Still, he has demonstrated ample flexibility.
In the 1990s he advocated stimulative austerity boosting growth by cutting
budget deficits and thus interest rates. Now he opposes it because interest
rates can t fall much. His support for easy fiscal policy suggests he would
want the same for monetary policy. At a conference this spring he noted
delphically that QE had boosted demand less than is supposed . Does this mean
he is sceptical of QE, or that to achieve a given result he might prescribe
even more?
Whereas Mr Summers s economics are close to Ms Yellen s, his personality could
hardly be more different. He attacks his opponents arguments with gusto. He
inspires fierce loyalty from colleagues many of whom are now advising Mr Obama
on the Fed appointment and resentment from people he has crossed. In 2006 he
resigned as president of Harvard University after clashes with faculty and
insensitive remarks about women, though his spells as treasury secretary and
White House adviser were free of such blips.
Mr Obama appears to favour Mr Summers, whom he knows much better than he does
Ms Yellen. Whoever he chooses could face a rough Senate confirmation hearing.
Some liberal Democrats think Mr Summers s advocacy of financial deregulation in
the 1990s is wrong for the Fed today. That would actually endear him to
Republicans, who might be wary of Ms Yellen s brand of dovishness.
From the print edition: Finance and economics