The financial press has narrowed down the race for the next Fed Chair to Larry Summers and Janet Yellen. Though there are other candidates with Democratic credentials, such as Alan Blinder and Tim Geithner, most stories are about a pairwise comparison: Between Summers and Yellen, who is closer to Barack Obama, more able to get along with Wall Street, more dovish, or better able to intervene in a serious financial crisis?
But the most important question is who is more likely to implement a monetary policy that will help keep us out of a serious financial crisis, and create price and output stability more generally. In other words who will implement a more predictable, less interventionist, more rules-based monetary policy strategy of the kind that has worked well when tried, as in the 1980s, 1990s and until recently?
Janet Yellen has spoken at length about this issue, and though Larry Summers has recently been in “radio silence” mode, he did discuss the issue in a debate I had with him last year at Stanford. So there is a basis for comparison using each person’s own words. And because Summers and Yellen both chose to discuss rule-like policy in terms of the Taylor Rule, it is not an apples and oranges comparison.
Here is what Janet Yellen has been saying about rules-based monetary policy, drawn from her speech of last November:
Many studies have shown that, in normal times, when the economy is buffeted by typical shocks—not the extraordinary shock resulting from the financial crisis—simple rules can come pretty close to approximating optimal policies. In fact, empirical research suggests that a modified version of the original Taylor rule fits the behavior of the Fed reasonably well from the late 1980s until the financial crisis. Given that participants in financial markets are familiar with both the FOMC’s historical behavior and simple rules, the communications challenges might arguably be less severe if the FOMC followed such a strategy. To be sure, I would never advocate turning over monetary policy to a computer, but why shouldn’t the FOMC adopt such a rule as a guidepost to policy? The answer is that times are by no means normal now, and the simple rules that perform well under ordinary circumstances just won’t perform well with persistently strong headwinds restraining recovery and with the federal funds rate constrained by the zero bound.
So, though Yellen rationalizes the departure from rules-based policy, she at least wants to get back to rules-based policy in normal times, largely because that will help, in her view, maintain greater macroeconomic stability.
In contrast, here is what Summers said at the Stanford debate (based on a video recording):
The Fed’s job is to set monetary policy and it may or may not have done the right job….Look, on monetary policy I have enormous respect for the Taylor Rule, but it is not yet the law of the land. So to call the failure to follow the Taylor Rule an argument that the government is somehow acting excessively and being the cause of the problem… I mean, yes. I think government should act more wisely in their macroeconomic policies. I think we probably can agree on that proposition. And I’m not choosing to argue with you on the proposition that the Taylor Rule would have represented more wise monetary policy at some point…. Look, are there things that were done in the wake of crisis that in with the benefit of hindsight you would have done differently? Of course. …was the right policy to have less government? I don’t see how you can come down on any side other than, thank God we had an activist government.
Like Yellen, Summers rationalizes the recent discretionary deviations from rules-based policy as due to special factors, but his words reveal less willingness to endorse a rules-based policy strategy, even in normal times, with a preference that government officials should simply “act more wisely” in their discretionary interventions.