President Obama will soon make one of the biggest economic decisions of his presidency: who should replace Ben Bernanke as chairman of the Federal Reserve. Since America's monetary decisions reverberate far beyond its borders, the world has an interest in having the best person in that job.
The good news is that, for all the political circus that has surrounded the decision, Obama is choosing from excellent candidates. The two leading contenders — Larry Summers, a former Treasury secretary and presidential adviser, and Janet Yellen, the Fed's current vice chairwoman — are both top-notch economists with years of relevant experience. Obama is said to be leaning toward Summers. The Economist would (narrowly) prefer Yellen. Although Summers is cleverer, she is better suited to this job now.
For decades the art of monetary policy has been to control inflation and counter recessions by pushing short-term interest rates up or down. Now weak growth, not inflation, is the biggest challenge, and the Fed has to rely on less tested and more controversial tools, such as bond-buying. The next chairman will need the judgment to navigate this new world and persuade financial markets (and skeptical politicians) that the central bank knows what it is doing.
Two 'doves'
Both Yellen and Summers are "doves," rightly worrying more about economic weakness than any threat from inflation, but it is clearer how Yellen would go about putting her views into practice. As the Fed's vice chairwoman she has pushed the current set of unconventional policies, from bond-buying to "forward guidance." Under her leadership, the central bank would influence market expectations with even more detail around its future plans. Her public demeanor would be much like Bernanke's: technocratic and based on meticulous command of the data. Her cautious, consensus-building approach would minimize surprises (and financial-market volatility), as the current chairman has.
Summers has a less clearly articulated approach to monetary policy and more political baggage. He has said little in public about how central banks can best support economies when short-term rates are at zero. Judging by his record in other areas, he is likely to push for creative solutions but to prefer not to have the Fed's hands tied by promises about its future direction. The chances are that a Summers Fed would be even bolder, but less predictable, than the Bernanke Fed. Summers' dazzling intellect would make for bravura public performances, but he would be more likely to unsettle the markets with unscripted comments and to alienate both other Fed governors and lawmakers.
The Fed has had "maestro-style" leadership before, notably under Alan Greenspan. That seemed fine, then, but these days the Fed uses more experimental tools, depends more on influencing expectations and has shallower political support. Transparency, predictability and consensus-building therefore matter more than they used to. Bernanke's low-key leadership has made it easier for him to be radical. Yellen would probably take a similar approach.
The Fed's other big task is to prevent (and, if need be, manage) crises. Here Summers seems stronger. Yellen delivered early warnings about the credit crunch and now helps oversee the Fed's crisis-fighting machinery. But she has no practical experience of handling a big financial mess and no firsthand knowledge of financial markets. In 2008 she was president of the San Francisco Fed, far away from the frantic efforts to stop a global meltdown.
The vilification of Summers for favoring financial deregulation in the 1990s is grossly unfair: Much of what he proposed was quite sensible, and the link between those decisions and the financial crisis is weak. He clearly has the upper hand in terms of crisis-management experience, having been at the center of almost every global financial flare-up since Mexico's near-default in 1994.
The difference between the two is small. Supporters of Summers argue that the administration would be making a big mistake if it did not employ the brightest policy-minded economist in a generation with unparalleled experience of dealing with financial trouble. They are right. If Obama really wants the best people in place, he should replace his uninspiring Treasury secretary, Jack Lew, with Summers.
It is a job that Summers did superbly for Bill Clinton and which plays more clearly to his strengths. Making the switch would require uncommon decisiveness from a president who is loath to change personnel. But Yellen at the Fed and Summers at the Treasury would make a first-rate team.
© 2013 The Economist Newspaper Limited, London. All Rights Reserved. Reprinted with permission.
