YELLEN VS. SUMMERS? DEPENDS ON RISKS OF NEW FINANCIAL CRISIS / THE WALL STREET JOURNAL

August 1, 2013, 3:09 PM

Yellen vs. Summers? Depends on Risks of New Financial Crisis

By Michael J. Casey

 

The debate over who should become the next Federal Reserve chairman has inevitably focused on the pros and cons of each candidate’s experience and character — on Fed Vice Chair Janet Yellen’s lengthy experience in monetary policy, for example, or on former Treasury Secretary Lawrence Summers’s profound capacity to think outside the box..
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Associated Press, Reuters

Left: Janet Yellen Right: Lawrence Summers

But if the choice does come down to these two, President Barack Obama shouldn’t just add up the pluses and minuses of each and pick the one with the highest score. He’ll also need to assign a probability to the prospect of another international financial crisis. That should dictate which person is best for the job.

First, the positive scenario: If the global economy and financial system stay on their current path of a gradual recovery, Ms. Yellen looks like the right choice.

In this environment, the challenges ahead for the Fed lie in figuring out the timing and communication of the slow withdrawal of its extraordinary monetary stimulus measures and then in eventually raising interest rates. This doesn’t call for outside-the-box thinking per se. It demands a measured, careful approach, one that’s carefully communicated to the American public and markets.

Here, Ms. Yellen’s advantages are clear. She is steeped in the nuances of Fed communication policy, having played a central role developing the carefully calibrated “forward guidance” it now employs to manage expectations over future policy. She also appears to have strong support in Congress — at least in the Democrat-controlled Senate that will need to approve her confirmation. She offers a steady path of evolution toward policy normalization.

Fed outsider Mr. Summers, on the other hand, might have a harder time building consensus for this task within a divided Federal Open Market Committee. He has a reputation for being a bit of a prickly character, and from his time as Treasury Secretary under Bill Clinton carries baggage for being part of what former Federal Insurance Deposit Corp. chair and Yellen-endorser Sheila Bair described as “the deregulatory cabal that got us into the 2008 financial crisis.” (It’s worth noting George Mason University economist Tyler Cowen’s argument, however, that Mr. Summers would have “more right-wing street cred” and so could be more favorable to Republicans on the Hill.)

But where Mr. Summers shines is when things go wrong. In the event of another serious financial crises — a new meltdown in the euro zone, for example — a capacity for radical thinking highlighted by University of California at Berkeley economist Bradford DeLong would be an asset. People who worked with Mr. Summers during the Asian crisis frequently cite his capacity to quickly comprehend the essence of a problem and devise unique solutions.

“To the extent that the job has become much more international and with more regulation and supervision within the new financial world order, that makes people such as Summers and former Treasury Secretary Tim Geithner compelling candidates,” says Deutsche Bank economist Joseph Lavorgna.

Still, the advantages of having Mr. Summers as crisis-manager-in-chief at the Fed might depend on what type of international crisis were to arise. A sharper-than-expected slowdown in the Chinese economy, for example, might not pose the same risk to U.S. banks or require the same kind of Fed intervention as, say, a meltdown in the Japanese government bond market.

Ultimately, Mr. Obama can approach this like a homeowner who is considering taking out insurance against a flood, earthquake or some other natural disaster. If things go as planned, Mr. Summers’ personality could get in the way of a smooth return to normality, which would make him a more expensive option — in terms of political and market stability — than Ms. Yellen. But he could be well worth the money if some unwelcome disaster strikes a blow at the global financial system’s foundations.