What a difference a year makes. Last year, the Jackson Hole conference was focused on how monetary policy and central banks were still effective at the zero lower bound if they were willing to take chances. It provided the intellectual basis for several "asks," including targeting states, allowing for conditional higher inflation under the Evans Rule, alongside a commitment to open-ended purchases in QE3. These asks were executed that winter.
This year it isn’t clear what “asks” there are for the Federal Reserve. Stop the taper? A higher inflation target? Targeting something else? More purchases? The Evans Rule and state-targeting established a specific goal that allowed us to measure whether or not the Federal Reserve was taking its responsibility seriously. There isn’t the same ask for this year.
Which is a problem, because there’s going to be a new Federal Reserve chair nominated in a few weeks. Last year, asking if the candidates supported the Evans Rule and QE3 would have helped us figure out if they took their role seriously. This year, the questions are more vague.
This hasn’t been helped by the lack of concrete writing on monetary policy during the crisis by the presumed frontrunner for the position, Larry Summers. As such, it’s hard to connect commentary on Summers with specific demands from monetary policy in the Great Recession. And much of Summers’ writings on financial reform are from before Dodd-Frank, so it is tough to link them to the specifics of what is happening right now.
Zachary Goldfarb at Wonkblog has a post, ”Here’s what Larry Summers would do at the Fed,” that tries to determine what Summers would emphasize. It’s “based on interviews with some of the people who know him best, primarily sources who have worked closely with him, along with parsing his public comments,“ which Goldfarb found while researching a longer piece on the politics of Obama nominating Summers.
You should read it, as I want to comment on four things that stand out from it. I hate formatting a post this way, but I want to use Goldfarb’s bullet points to emphasize what questions people should have of Summers if his name goes forward. Bold is Goldfarb:
“Summers wouldn’t be any more dovish or hawkish than Ben Bernanke… While he’s likely to focus on employment while inflation remains low, he’ll be a hawk if inflation starts to rise much beyond the 2 percent target.”
If Summers would get aggressive if inflation started to rise above 2 percent, that would be significantly more hawkish than current policy, which has the Federal Reserve willing to tolerate inflation until 2.5 percent if it’s seen as controlled. If it became an important part of his policy, the Fed could reinstate a de facto 2 percent ceiling on inflation.
Bernanke spent 2011-2012 moving the FOMC to endorse the Evans Rule. On the first read, it’s not clear that Summers would have done that if he had been appointed back in 2010, especially if he was skeptical of QE in general. If this is the case, it’s a major abandonment of what was hard fought for by doves like Bernanke and Janet Yellen.
More generally, many economists are calling for a move to a higher inflation target, both as a means to deal with our current recession and to prevent future episodes at the zero lower bound. If Summers is excluding this possibility out of hand, that’s a problem.
“He thinks capital is king.”
The biggest question in town is whether or not U.S. regulators should raise capital requirements over what is required in Basel III. Daniel Tarullo thinks so. So does the FDIC. The administration is currently seen as being opposed to this. As Undersecretary for Domestic Finance Mary Miller said in a recent speech pouring cold water on the idea, “It is important to consider the totality of what the Dodd-Frank Act and Basel reforms do and give existing reforms time to take both shape and effect.”
If Summers agrees with Treasury, then expect him to make life difficult for Daniel Tarullo. If he agrees with Tarullo, that’s great for Tarullo. But if that’s the case, why hasn’t Summers done anything to publicly support him while Tarullo has stuck his neck out?
“He would use the Fed to pressure global banks to be more transparent and accurate.”
Summers is concerned about foreign financial institutions and their regulatory status. If you are concerned about foreign regulators and foreign standards for the financial sector, the biggest issue, by far, is cross-border derivatives. Should foreign subsidiaries of U.S. financial firms follow United States rules or weaker European rules?
As Gary Gensler, the chair of the CFTC, has argued, “All of these common-sense reforms Congress mandated [in Dodd-Frank], however, could be undone if the overseas guaranteed affiliates and branches of U.S. persons are allowed to operate outside of these important requirements.”
The administration did not agree. According to a blockbuster story by Silla Brush and Robert Schmidt at Bloomberg, Treasury Secretary Jack Lew put pressure on Gensler to back off this part of Dodd-Frank. According to the story, Gensler had “been hearing the same request from lobbyists seeking to slow the process, and he told the Treasury chief it felt like his adversary bankers were in the room.”
As a potential member of FSOC, Summers would have a lot of influence in supporting or stopping the CFTC. As with capital requirements, does Summers support the administration and the Treasury Department seeking to cool Dodd-Frank rule-writing, or does he support people like Tarullo and Gensler seeking to write more aggressive rules?
As a reminder, Summers does not have a great track record of respectfully dealing with regulatory heads who want more aggressive reforms than he wants while in public office. And, oddly, his connections to the administration could cause him to fight, rather than support (or just ignore), these regulatory heads pushing more aggressively.
“If a crisis did occur, he’d be no-holds-barred.”
Minor aside point, but I haven’t seen whether or not Summers supports the limits to the 13(3) powers the Federal Reserve invoked in 2008. Section 13(3) of the Federal Reserve Act was amended under Dodd-Frank so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company," and any such lending program has to have "broad-based eligibility.” The Federal Reserve will also need permission from the Treasury Secretary before proceeding in some cases.
This is designed to prevent the Federal Reserve from being no-holds-barred in rescuing an individual firm (like AIG) instead of an entire market (like commercial paper). This may be a big wake-up call come the next financial crisis, and I'm curious if the Fed would simply push in ways that try to circumvent the rule.
This is just a baseline, but it shows how much is still open when it comes to the future of monetary policy and financial reform. Or the two biggest things the next Fed Chairman will have to deal with.