The False Furor Over Larry Summers
So who had “Larry Summers voluntarily withdraws his name from consideration” in the office Fed Chairman Replacement Pool? Yeah, me neither.
This is obviously something of a coup for the progressive headhunters who were determined to bring down his nomination. Undoubtedly, Summers counted heads in the Senate and found they didn’t add up to his appointment as the chairman of the Federal Reserve. Along the way, he would have been an even bigger target for complaints about sexism -- even more unfair than the ridiculous brouhaha at Harvard, given that Summers is not the person selecting nominees, and can hardly be blamed for either being male or wanting a prestigious position at the helm of financial markets regulation.
This probably clears the way for Janet Yellen to become the Fed chairman, and she’ll probably make an excellent one. Though she will not, I think, be quite as excellent as her supporters are expecting. The fervor over the identity of the next Fed leader has always struck me as out of proportion to the actual importance of the pick. Oh, don’t get me wrong: I think the Fed chairman matters. And I frequently pause for a moment of silence wherein I thank our lucky stars that Ben Bernanke happened to be at the helm of our central bank when the financial system threatened to come crashing down around our ears.
But Bernanke was in a singular position. During the financial crisis, the Treasury Department and the Federal Reserve assumed extraordinary, and arguably extra-legal, powers. And if you had asked yourself before the crisis who could be trusted to take those powers, you would probably have named Bernanke, an extraordinarily gifted economist and student of the Great Depression. In the face of a crisis like no one living had ever faced, he was flexible, creative and decisive. You have only to read Liaquat Ahamed’s brilliant history of the Great Depression’s central bankers to realize how much worse it could have been.
But the next central banker will not have that kind of power, in part because Congress has moved to take it away. She (or he) will be first among equals at the Fed, not a finance czar wielding emergency powers. People tend to focus too much on the person sitting in the boss’s chair, and to underweight the institutional inertia that constrains that person's ability to radically shift direction.
I don’t really think that Yellen is a radical. But even if she were, she could not do radical things. The Fed is not going to target a 4 percent inflation rate, however much you think this would be a good idea, because there is no constituency at the Fed for a 4 percent inflation rate, and no crisis sufficiently bad to call forth such a response. Crisis aside, the last radical innovation at the Fed was taking interest rates up to 20 percent under Paul Volcker, but that was a response to inflation that seemed on the verge of running away -- and a recognition that despite the inflation, we still had the persistently high unemployment that the inflation was supposed to fight. That’s a lesson that central bankers remember, even if their critics don’t.
It’s not that there would be no difference between a Yellen Fed and a Summers Fed. Yet those differences, while important, were never going to be spectacular. There’s a lot of folk economics running through the panic about Summers. For example, people seem to forget that using monetary policy to combat unemployment is not quite as simple as just running up the inflation rate a little higher to get unemployment a little lower, because expectations adjust over time.
At least as I learned it at the University of Chicago, once people are expecting 3 percent inflation instead of 2 percent inflation, they adjust wage and price demands accordingly, and the unemployment rate settles back toward its old level, because the higher prices and higher wages that were signaling “economic boom” are now just signaling “same old, same old.” Unless the underlying structural problems in the economy are fixed, you either end up with high unemployment and higher inflation (as we did in the 1970s), or you need accelerating inflation -- you kick the inflation rate up to 4 percent, and then expectations adjust so you kick it up to 5 percent and so on, until inflation is a huge problem. No modern central bank in a rich-world country is going to let this happen. This is one more reason that we are talking, when we talk about the various candidates for Fed chairman, about relatively small policy differences.
If there was a reason to worry about Summers, it was that he might not have been good about herding the cats -- developing consensus on the board and otherwise shepherding the institution toward presenting a strong and mostly unified presence in financial markets. Summers is undoubtedly a brilliant economist, and also, I think, a good counselor. It’s less clear that the minutiae of management appeal to him.
It would of course be disastrous if we nominated someone incompetent or unqualified to the Fed, but that describes none of the remaining candidates. And it didn’t describe Summers either. I feel badly for Larry Summers, who was surely hoping that this would be the capstone of a distinguished career in public service. But I have no worries at all for the fate of our central bank.