The media circus over who will be the next chairman of the Federal Reserve is, on the one hand, an unwelcome spectacle at a time when uncertainty over the outlook for U.S. output and jobs growth is high.
While previous leadership transitions have brought forth speculation about candidates, the current “contest” is odd. President Obama, after ungraciously commenting on Chairman Bernanke’s reappointment prospects, wisely stepped back for a period of reflection and decision about “what” he wants as well as “who” he wants.
On the other hand, this period also offers an opportunity for the White House to turn questions for the next chairman to consistent questions about the administration’s own economic policies. Four areas provide an immediate point for comparison.
The first is about the Fed’s role in supporting economic growth. A core element of the desire for Fed policy to enhance near-term growth and employment prospects is the Fed’s reduction in longer-term interest rates via its large-scale asset purchases (“quantitative easing”). The link here is from lower long rates to higher investment spending by households and businesses, with gains in GDP bolstering employment. Chairman Bernanke has justified continued quantitative easing to augment the economy’s growth momentum. A problem: the pace of growth actually decreased from 2010 to 2011 to 2012, suggesting a less than robust correlation.
The question for the president: The most optimistic estimates of economic gains from quantitative easing from Chairman Bernanke’s Jackson Hole remarks last August indicated that the first three rounds of quantitative easing reduced the 10-year Treasury yield by 80 to 120 basis points and may have raised the level of output by as much as 3 percent by 2012. Other estimates are much more modest, as the raw data suggests. (A problem here is that it is difficult to assess how economic conditions would have evolved if the unconventional policy had not been in place.) But many economists have argued that fundamental tax reform remains the most potent growth–raising weapon in the government’s arsenal — with estimated gains in GDP growth of a half to a full percentage point per year for a decade. Why is it important to have a Fed chair that continues quantitative easing, while failing to have the administration work with Congress to advance fundamental tax reform? In spite of the spillover from the Fed’s asset purchases into higher asset prices, does the president believe that additional quantitative easing has more favorable distributional benefits than tax reform? Does the president’s proposal that corporate-only tax reform coupled with a tax increase on large global firms and small businesses match the growth rhetoric?
Second, by its history as lender of last resort and much enhanced by the Dodd-Frank Act in 2010, the Fed has an outsized role in financial regulation in general and banking regulation in particular. Many commentators have rightly observed that knowledge of financial markets and institutions and how financial excesses build up is key for the next Fed chair. But so, too, does it raise questions for the president in his consideration. Who will advocate for economic growth as well as safety and soundness in financial regulation? How will the Fed’s pursuit of Systemically Important Financial Institutions not enshrine the current “too big to fail” financial institutions? Will the administration pursue reform of housing finance, given the role played by government-sponsored enterprises in the run-up to the financial crisis?
Third, much attention has been paid to the need for clear communication and consensus-building skills for the Fed chair. Chairman Bernanke has been clear in guidance for the future course of the federal funds rate. He has also been clear about the conditions under which the Fed will “taper” its large-scale asset purchases. The chairman has built a broad consensus within the Federal Reserve System for unconventional monetary policy. For the president: Do questions of communication and consensus-building extend to fiscal policy as well? Is a clear path for tax policy and budget policy important? If so, what is the administration’s proposed path? How would the president rate the administration’s consensus-building leadership of economic policy?
Fourth, Fed Vice Chair Janet Yellen, one logical candidate to succeed Bernanke, noted last year that the Federal Open Market Committee would benefit from employing simple rules for monetary policy in more normal times. For the president: Does a strategy of returning to normal apply to the size of government and government’s reach in the economy as well? Is the run-up in government spending growth a change the government should reverse in more normal times?
The media “contest” for Fed chairman is as distracting as the president’s virtual dismissal of Ben Bernanke’s chances is inappropriate. There are important “what” questions to be evaluated before the president decides “who” his choice is. But equally important are the “what” questions for the president about the economic agenda he already leads — the government’s — squaring his growth rhetoric for the Fed with the administration’s policy choices.
By Glenn Hubbard | This op-ed appeared online on August 4, 2013 on Reuters.com