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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