The Federal Reserve in a Time for Doves

CAMBRIDGE – The battle is on to replace current US Federal Reserve Chairman Ben Bernanke. One might expect the Fed chairmanship – arguably the second most powerful official position in the United States, and certainly the world’s most powerful financial position – to be determined by a conclave of central bankers. In fact, the choice is largely at the discretion of the US president. So let us consider two of the leading candidates, Lawrence Summers, a former US treasury secretary, and current Fed Vice Chair Janet Yellen.

Both Summers and Yellen are brilliant scholars with extensive experience in public service. Whereas the mainstream press seems intent on exploring their candidacies as a contest of contrasting personalities, the fact is that both candidates are extremely well qualified. Moreover, both have a reputation for believing that the Fed should not place excessive weight on price stability relative to unemployment. Normally, this dovish bias would be a handicap; nowadays, it is an advantage.

The importance of technical competence in monetary policy has been proved repeatedly by central banks around the world. According to research published in 2003 by the economists Christina Romer and David Romer, the quality of monetary policy depends critically on whether central bankers have a clear and nuanced understanding of policy making and inflation. The 1920’s, 1930’s, and 1970’s are replete with examples of central bankers who did not understand the basics, and whose economies paid the price.

What this means is not just competence in setting interest rates, but also competence in regulatory policy. Some are criticizing Summers’s ardent pursuit of financial deregulation during the 1990’s, when he headed the US Treasury under President Bill Clinton. But these critics overlook his role in helping to fight that decade’s sovereign-debt crises, and his insistence that the US begin issuing inflation-indexed bonds.