Yellen, Summers and Rebuilding After the Fire

By Mike Konczal |

There is no Bernanke Consensus. This is important to remember about our moment, and about how to evaluate what comes next for the Federal Reserve. What we have instead is the Bernanke Improvisation, a series of emergency procedures to try to keep the economy from falling apart, and perhaps even guide it back to full employment, after normal monetary policy hit a wall.

With the rumor mill circulating that Larry Summers could be the next Federal Reserve chair instead of Janet Yellen, it’s worth understanding where the Fed is. Bernanke has been like a fireman trying to put out a fire since 2008. What comes next is the rebuilding. What building codes will we have? What precautions will we take to prevent the next fire, and what are the tradeoffs?

This makes the next FOMC chair extremely important. While you are inside a burning building, what the fireman is doing is everything. But deciding how to rebuild will ultimately make the big difference for the next 30 years.

The next FOMC chair will have three major issues to deal with during his or her tenure. The first is to determine when to start pushing on the brakes, and thus where we’ll hit “full employment.” The second is to decide how aggressively to enforce financial reform rules [1]. Those are pretty important things!

But the new FOMC chair has an even bigger responsibility. He or she will also have to figure out a way to rebuild monetary policy and the Federal Reserve so that we won’t have a repeat of our current crisis. And in case you’ve missed the half-a-lost-decade we’ve already gone through, this couldn’t be more important.

Monetary policy itself could be rebuilt in a number of directions. It could give up on unemployment, perhaps keeping the economy permanently in a quasi-recession to somehow boost a notion of “financial stability” instead. Or it could evolve in a direction designed to avoid the prolonged recession we just had, which could involve a higher inflation target or targeting something like nominal GDP.

But the default, like many things in life, is that inertia will win out, and some form of muddling forward will continue on indefinitely. The Federal Reserve will maintain a low inflation target that it always falls short of, and the economy will never run at its peak capacity. Attempts at better communications and priorities will be abandoned. And even minor recessions will run the risk of hitting the liquidity trap, making them far worse than they need to be.

The inertia problem is why having a consensus builder and convincer in charge is key, and it is a terrible development that these traits are being coded as feminine and thus weak. As a new governor in 1996, Janet Yellen argued the evidence to convince Alan Greenspan that targeting zero percent inflation was a bad idea. (Could you imagine this recession if inflation was already hovering at a little above zero in 2007?) The next governor will be asked to gather much more complicated evidence to make even harder decisions about the future of the economy – and Yellen has a proven track record here.

Yellen has been at the forefront of all these debates. As Cardiff Garcia writes, she runs the subcommittee on communications and has spent a great deal of time trying to figure out how these unorthodox policies impact the economy. The debate about what constitutes full employment has become muted among liberal economists because unemployment has been so high, but it will come back to the fore after the taper hits. Yellen has been thinking about this all along. Crucially, she has come the closest of any high-ranking Fed official to endorsing a major shift of current policy – in this case, to something like a nominal spending target. This will become important to however we rebuild after this crisis.

As a quick history lesson, there were two major points where a large battle broke out on monetary stimulus. The first was the spring and summer of 2010, when there were serious worries about a double-dip recession. This ended when Bernanke announced QE2, which immediately collapsed market expectations of deflation. The second was in the first half of 2012, when an intellectual consensus was built around tying monetary policy to future conditions, ending with the adoption of the Evans Rule.

I can’t find Larry Summers commenting on either of these situations, either in high-end academic debates or in the wide variety of op-eds he’s written. The commenters at The Money Illusion couldn’t find a single instance of Summers suggesting that monetary policy was too tight in the past five years. Summers was simply missing in action for the most important monetary policy debates of the past 30 years, while Yellen was leading them. And trying to shift from those debates into a new status quo will be the responsibility of the next FOMC chair.



[1] Given what this blog normally covers, I’d be remiss to not mention housing and financial reform. During the Obama transition, Larry Summers promised “substantial resources of $50-100B to a sweeping effort to address the foreclosure crisis” as well as “reforming our bankruptcy laws.” This letter was crucial in securing votes from Democrats like Jeff Merkley for the second round of TARP bailouts. A recent check showed that the administration ended up using only $4.4 billion on foreclosure mitigation through the awful HAMP program, while Summers reportedly was not supportive of bankruptcy reform.

And as Bill McBride notes, Yellen was making the correct calls on the housing bubble and its potential damage while Summers was attacking those who thought financial innovation could increase the risks of a panic and crash.

It’s difficult to overstate how important the Federal Reserve is to financial regulation. Did you catch how the Federal Reserve needs to decide about the future of finance and physical commodities soon, with virtually no oversight or accountability? Even if you think Summers gets a bum rap for deregulation in the 1990s, you must believe that his suspicion of skepticism about finance – for instance, the reporting on his opposition on the Volcker Rule – is not what our real economy needs while Dodd-Frank is being implemented.

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Mike Konczal is a Fellow with the Roosevelt Institute, where he works on financial reform, unemployment, inequality, and a progressive vision of the economy. His blog, Rortybomb, was named one of the 25 Best Financial Blogs by Time magazine. Follow him on Twitter @rortybomb.