Don’t Crush the Fed’s Independence
Felix Salmon wrote a piece a little while ago arguing that President Obama’s nomination of Larry Summers to head the Federal Reserve would be the culmination of the politicization of the institution. He noted:
Make no mistake: Summers would be the most political Fed chair in living memory. Greenspan was pretty bad, especially when he testified — in clear support of the Bush administration’s tax cuts — that we had reason to be worried about budget surpluses. But Summers has been one of Obama’s closest economic advisers since the day that Obama took office: he’s much closer to Obama than Greenspan was to Bush.
Summers has spent most of the past five years doing everything in his power to shape and advance Obama’s agenda. Obama, of course, is very happy about this, and would love to reward Summers for his loyalty by handing him the Fed chairmanship.
That’s a move even Clinton would never have dared make: he kept Greenspan at the Fed for his whole presidency. And it sets a horrible precedent: the next Republican president will henceforth have no compunctions whatsoever about appointing a party hack to the post. From here on in, if Summers gets the job, we won’t just be voting for president in presidential elections. We’ll be voting for Fed chair, too. And the Fed will become just as politicized as the Supreme Court has become.
Salmon is being a bit overly dramatic here. While Obama’s nomination of Summers would be treated as a political appointment, it would also be the selection of a highly qualified economist who has extensive experience in and out of government. It wouldn’t be as good of a choice as Yellen. But it would still be pretty darn good. A Republican administration couldn’t nominate just anyone for the job. It would still have to be highly qualified candidate. And Mitt Romney’s rumored front-runners to take over for Ben Bernanke (Glenn Hubbard, John Taylor and Greg Mankiw) would have been equally as political Summers would be. Republicans are already working under the assumption that the Fed isn’t independent and we were already voting for a Fed Chair last November.
In a response to Salmon’s post, Slate’s Matt Yglesias commented that he doesn’t think this is a bad thing:
These are, however, both dysfunctions induced by the cult of central bank independence. A central bank chief who saw himself as a close political ally of the president, and recognized that poor macroeconomic performance would reflect poorly on the skills of his friends, colleagues, and protégés on the economic team, might be willing to put inflation paranoia aside. Even better, precisely as the Obama team apparently “worried” back in 2009, financial markets might believe he’d be willing to tolerate more inflation. That would be a de facto rate cut, and would boost the economy.
Of course, in the longer term, this strategy only works if the central bank chief really iswilling to overlook a bit of inflation in order to boost the economy. The belief that he’ll do it starts the cycle, but doesn’t end it. So the mere fact that people worry Larry Summers won’t be independent enough counts as a consideration in his favor. But to really seal the deal, he has to follow through and actually compromise the Fed’s inflation-fighting mission in order to help his friends in the White House.
I’m still not sold on the idea that he’s the best person for the job. But at the end of the day, Summers’ ties to the White House are a feature, not a bug. If Obama goes with him, as it looks like he will, let’s hope Summers doesn’t forget that he owes his position to a relatively narrow circle of friends that just so happens to include all the key economic decision-makers in the administration, and he owes them some favors.
This is a pretty scary post from Yglesias. Why not just make the Federal Reserve a cabinet in the government? There’s a very specific reason that the Fed is an independent institution: the best monetary and regulatory policies are not always in the best interest of the President and his administration. In the aftermath of the Great Recession, this has not been the case. Yglesias is right that the best thing Bernanke could have done was to allow for more inflation to spur on greater economic growth, which would’ve helped Obama stay in office. But that is just the case right now. It’s easy to think of counterexamples when a Federal Reserve chair too close to the President could lead to bad macroeconomic outcomes.
For instance, at times the Fed may have to raise interest rates to quash inflation, but this can induce a recession, which is certainly not in the President’s interest. This is what Fed Chair Paul Volcker accomplished in the late 1970s. Starting in 1977, the Fed started to raise interest rates, causing the economy to enter into a nasty recession. In 1980, President Jimmy Carter was defeated by Ronald Reagan, thanks in large part to the poor economy. The Volcker-induced recession may have cost Carter a second term (there were plenty of factors), but it tackled inflation. A less independent Fed may have been slower to raise rates to cut down on inflation. Is that something we want?
Or take regulation. New regulations impose compliance costs on companies. Many rules are created to prevent future crises. They hinder economic growth in the meantime, but are vital to the economy in the long-run. Yet, a less independent Fed Chair could feel pressure from the White House to implement looser financial regulations to spur on greater growth in the near-term and let a future president deal with the long-run costs. That sounds like a recipe for disaster as well. Thus, it’s incredibly important that we have an independent Federal Reserve.
If Obama nominates Summers, he won’t be selecting the best candidate for the job, but it will still be a very good one. It won’t be the culmination of the politicization of the Fed and that’s a good thing. It will be a strong choice and Summers will likely do a good job in the position. Let’s not blow this out of proportions.