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.


A Terrorist Attack from a Plane is More Likely than One from a Bus

Matt Yglesias has a good post up on his blog arguing that intelligence agencies should be required to perform cost-benefit analyses of potential security policies before implementing them. Josh Barro wrote a similar column yesterday. Within Yglesias’s post, he notes that buses have no security yet terrorists do not routinely blow them up:

As I’m going to be boarding a flight to Brussels soon, I’ve just had the opportunity to reaquaint myself with the banal aspects of the post-9/11 national security state—liquids out of your bags, full-body scans, etc. The purpose, as ever, is security. After all, if airplanes were no more secure than city buses then we’d see terrorists blowing up airplanes about as often as they blow up city buses.

At any rate, that’s my view. Approximately zero lives per year are saved by airport security measures. Some amount of economic cost is directly inflicted, and then there’s a secondary cost as people substitute dangerous driving for safe flying.

While I wholeheartedly agree that the Department of Transportation should be required to estimate the costs and benefits of new security policies, I don’t agree with the above analogy. Certain security measures may not be worth their costs, but if we reduced airport security to the levels seen on buses, would-be terrorists would have strong incentives to carry out an attack.

First, an airplane can be used as a weapon in a way a bus can’t. If a terrorist were to hijack a bus and attempt to drive it into a major building, there are a number of ways that law enforcement can stop the attack from succeeding. In many situations, police will find out quickly about such an incident and can respond in kind. They can set-up blockades, shut down parts of the city and track the vehicle easily. On an airplane though, law enforcement have few methods to respond. They cannot simply shoot the plane down and sacrifice the Americans on it. There is no way to set up a blockade.

Second, bus riders can text or phone friends to alert the authorities if the attack is not clear. In the air however, passengers cannot easily communicate with friends and family on the ground. Notifying the authorities of the attack is much more difficult from the sky than from the ground.

Third, a terrorist attack from a plane has the potential to be much more deadly than one on a bus.  At the very least, there are more people on a plane than on a bus. But terrorists can also inflict significantly more damage crashing a plane into a tall building or a secure location than they can running a bus into a similar target. Planes can crash into locations that cars and buses cannot even travel to (for example, the White House). This makes a hijacked plane much more dangerous than a hijacked bus.

Fourth, an attack from the sky is more emotionally damaging than one from the ground. We are unfortunately becoming more used to mass shootings and other threats on the ground. Part of the reason that 9/11 scared Americans so much was that it was the first time that we were attacked from the sky. That’s part of what makes drones so scary for Middle Easterners. You can’t see them and don’t know that they’re there – but they can strike at any moment. Before 9/11, we didn’t think twice about such a threat. Afterwards, we are now all alert and aware that we are not immune. A bus bombing would terrify us, but we can see a bus coming from a distance and can attempt to avoid it if it’s heading right at you. If you are so scarred from such an event, you can avoid buses for the rest of your life. You can’t avoid a plane striking your home or office out of nowhere. You don’t see it coming until it’s too late and there’s no way to fully protect yourself. That fear sticks with you for the rest of your life.

For all those reasons, terrorists have greater incentives to hijack a plane than a bus. That’s why Yglesias’s analogy doesn’t work. Now, there are some TSA policies that almost certainly have costs greater than their benefits (banning pocket knives) and Yglesias is right that we need agencies to conduct cost-benefit analyses more often. With specific estimates of the costs and benefits of a proposed policy, politicians will have more confidence in supporting less security. After all, no politician wants to risk advocating for reduced security and then face voters if a terrorist attack does happen. This biases the entire system towards excessive security. At least with a cost-benefit analysis, Congressmen will have specific statistics to show their constituents for why they voted for such a policy. If that alone can reduce the bias in the system, it’s worth a shot.

Did the Fiscal Cliff Hurt the Economy?

Today’s jobs report was decidedly mediocre and unremarkable – the economy added 157,000 jobs in January. The Bureau of Labor Statistics also revised its November and December estimates up a decent bit as well. This seems to rebuke the idea that uncertainty surrounding the Fiscal Cliff held back the economy. After all, we continued to gain jobs at a similar pace as we had during the previous 10 months. The Fiscal Cliff didn’t seem to have a significant effect, right? That’s Matt Yglesias’s take:

With today’s jobs report out, it’s worth remembering that back during the lame duck session, the Fix the Debt crowd was constantly braying about the dire consequences of failing to reach a major budget deal. They said that not only would full implementation of the cliff be a Keynesian drag on the economy but also that fire and brimstone would rain down upon us if markets weren’t assured that Congress has a credible plan to tackle long-term fiscal challenges.

Well, Congress had no plan. They agreed to small tax hikes and a bit of new stimulus via unemployment insurance, randomly kicked the can on the sequester, did nothing to reform the tax code and nothing to settle entitlements. And everything’s … fine.

Not great, mind you. But a January jobs report showing normal growth, no bond market freakout, no interest rate spikes, and some nice upward revisions to data from the lame duck period. Uncertainty didn’t matter. Confidence didn’t matter. Strong fundamentals and decent monetary policy from the Federal Reserve have us on a track for O.K.-but-not-spectacular growth, and you should expect that to continue.

Everything is fine, but that doesn’t mean that the economy wouldn’t be better right now if Democrats and Republicans had come together and agreed on a big deal. Certainly, all the pundits screaming that the world would fall apart if we didn’t get a grand bargain were wrong. We are doing fine without a grand bargain. But that doesn’t mean the Fiscal Cliff didn’t harm the economy. Maybe we would’ve added 300,000 jobs in December and January if we reached a more comprehensive deal.

So, I disagree with Yglesias’s post that uncertainty and confidence didn’t matter. I think they did, even if just slightly, but it’s impossible to know how much they mattered without knowing what the economy would be like in an alternate universe where we had a major deal. Until then, it remains a mystery.