President Obama appears to think the two leading candidates to chair the Federal Reserve agree on monetary policy. On July 31 he told a group of Democratic senators that “when it comes down to their basic philosophy on the future of the Fed,” the differences between the candidates were so small “you couldn’t slide a paper between them,” according to Senator Dick Durbin of Illinois, who was at the meeting.
Obama might want to take a closer look at the candidates’ records. The fact is, you could slide a fairly thick doctoral thesis between the policy views of Larry Summers and Janet Yellen. In a nutshell, Summers is more skeptical than Yellen about the ability of easy money to accelerate economic growth; he also says the economy is closer to operating at full capacity than Yellen does. A Summers Fed would probably raise interest rates sooner than a Yellen Fed would.
Most of the commentary about the race to succeed Ben Bernanke next February has focused on gender, personality, and regulatory philosophy. All entertaining and important, but setting monetary policy will be the next chairman’s most important job. If Obama picks Yellen he’ll be casting his lot with faster growth and more jobs at the possible cost of higher inflation and asset bubbles. Choosing Summers is a vote for a more cautious approach—at the risk of higher unemployment.
Yellen, who turns 67 this month, and Summers, 58, are both liberal-leaning economists with distinguished academic records—she at the University of California at Berkeley and he at Harvard. Yellen is married to a Nobel prize winner, George Akerlof. Summers is the nephew of two Nobelists, Paul Samuelson and Kenneth Arrow.
That doesn’t make them interchangeable. “Yellen would probably be more committed to keeping stimulus in place until the economy was definitely recovered,” says Michael Feroli, chief U.S. economist at JPMorgan Chase. “Summers perhaps could be persuaded that … the economy’s speed limit is lower, and when it’s reached that’s when you need to apply the brakes.”
Yellen and Summers have gone head-to-head before. Both were candidates for the Fed job four years ago before Obama asked Bernanke to stay on for a second term. In 1999 they were both mentioned as possible successors to Robert Rubin as President Clinton’s Treasury secretary; Summers got that one. In 2009 and 2010, Summers developed close ties to Obama as the first director of his National Economic Council. Yellen, the Fed’s vice chairman, advised Clinton but has no personal connection to the Obama White House, which could hurt her chances.
If picking a strong regulator were Obama’s main priority, Yellen would be the clear choice, simply because Summers’s record in that area is weak. In 1998 he helped prevent the U.S. Commodity Futures Trading Commission under Brooksley Born from regulating over-the-counter derivatives. In 1999 he hailed the death of the Glass-Steagall Act that had separated commercial and investment banking for decades after the Depression, calling it “an archaic set of restrictions.” This year, as he was being considered to run the Fed, it came to light that he’d landed work as a well-paid consultant to Citigroup—the megabank whose creation precipitated the death of Glass-Steagall and which later required massive government assistance to survive the financial crisis.
When it comes to steering the economy, Summers has repeatedly urged Congress to pursue more stimulus or at least less austerity, pointing out that the taxing and spending under Congress’s jurisdiction are more powerful than the Fed’s monetary policy when short-term interest rates have hit zero. That’s true, but it’s not a reason for the Fed to do less than it’s capable of. Even in sophisticated macroeconomic models, two wrongs don’t make a right.
You don’t have to rummage through old archives to find Summers expressing skepticism about what the Fed can and should do. As recently as April he said, “More of what will determine things going forward will have to do with fiscal policy,” according to notes prepared by Drobny Global Advisors, which hosted the conference in Santa Monica, Calif., where he was speaking. Summers added, “There is less efficacy from quantitative easing than is supposed.” He also predicted that estimates of slack in the economy would “come down significantly” over the next 18 months. As that occurs, he said, the Fed’s “tightening phase [will] happen sooner than is now supposed by many.”
Yellen, by contrast, said at an International Monetary Fund conference in April that interest rates controlled by the Fed “should, under present conditions, be held lower for longer than conventional policy rules imply,” according to her prepared remarks. She added, “I believe that the clarity of this commitment to accommodation will itself support spending and employment and help to strengthen the recovery.”
Getting monetary policy right is trickier than ever, because the Fed is doing things unprecedented in its 100-year history. For one thing, it’s trying to get inflation higher, not lower. A “hawk” used to be someone who thought inflation was too high. Now, one could argue, it’s someone who wants to get the inflation rate back up to the Fed target of 2 percent, says Paul Sheard, chief global economist for Standard & Poor’s Ratings Services. (Sheard wrote a July 29 report for S&P called “ ‘Hawk’ and ‘Dove’ Labels Are for the Birds.”) In an interview he said that for the Fed, removing “historically extraordinary” stimulus as the economy recovers “will be like flying a new aircraft that’s never been flown before.”
These are perilous times for the Fed. Markets gyrate every time Bernanke or another member of the Federal Open Market Committee says something new and seemingly contradictory about plans to taper the pace of bond buying. “The Fed has to be very careful what it does with its reputation here,” Mohamed El-Erian, chief executive officer at Pacific Investment Management, said in a June interview on Bloomberg TV. El-Erian is freshly upset over the public jousting between supporters of Yellen, Summers, and dark horse candidates for the Fed job (including Roger Ferguson, Donald Kohn, and Timothy Geithner). “What’s really unfortunate is how public and polarized this debate has gotten.”
Harvard Business School economist Julio Rotemberg argues that the Federal Reserve evolves through “penitence after accusations of error.” In other words, he said at a National Bureau of Economic Research conference in July attended by Bernanke and other luminaries, each era is a reaction to the supposed sins of its predecessor. Money was too tight in the 1950s, so it became too loose in the ’60s and ’70s. The question is what error the Fed will try to atone for now. Will it raise rates soon to avoid another bubble such as the one that burst in the 2000s? Or will it maintain low rates to avoid a relapse like the one in 1937 that caused the second stage of the Great Depression? That will depend partly on whom Obama picks for chairman.