Who has the Edge in Race to Head the Fed?

One of the most common mistakes policy analysts make is what I like to call ‘normative bias’—allowing personal opinions to affect perceived odds of certain outcomes1. Saying “The Fed is unlikely to introduce quantitative easing because it would lead to high inflation” is an example of normative bias. Fed officials do not think quantitative easing (QE) leads to high inflation, and whether you think it does has no bearing on the probability. Personal perceptions are irrelevant for policy analysis—the only things that matter are the perceptions of the decision maker.

Normative bias seems to be coloring market views on the odds of the next Fed Chair. Based on surveys and our own conversations, it appears that most observers continue to think Janet Yellen will succeed Ben Bernanke, rather than Larry Summers. This contradicts the reporting of the Washington Post, the New York Times, and the Financial Times. In addition, President Obama and his advisors have been quick to defend Summers in response to criticism from their own party. The consensus view seems to be based on the argument that Summers would be a bad Fed Chairman and therefore the President is unlikely to select him. But this argument does not carry much weight because President Obama—the only person whose opinion matters—doesn’t agree.

More specifically, the case for Summers within the White House seems to be based on three main points:

First, the President perceives Larry Summers to be an effective crisis manager. Summers advised candidate Obama while he was running for office in 2008, and crafted many of the crisis-response programs launched in the early days of the administration. The President seems to be putting a high weight on this experience. As the Financial Times’ Robin Harding reported, “People briefed on the process say the Obama administration has framed its selection criteria in a way that makes Mr. Summers, a former Treasury secretary, the obvious choice.” Top White House advisors feel the same way. David Axelrod tweeted yesterday: “I worked with Summers for two years in WH, and POTUS is right: His counsel in crisis was brilliant and indispensable.” This is not to say that Yellen would not be an effective crisis manager—only that the President has seen that attribute first hand in Summers.

Second, Janet Yellen does not appear to have much of a relationship with the President. The Washington Post reported that since Summers left the White House he has visited 15 times, while Yellen has visited only once (and that was to meet with Alan Krueger, not Obama). Similarly, the New York Times’ Annie Lowrey noted that Yellen is a “relative unknown in WH” and also that she clashed with NEC Director Gene Sperling in the 1990s (via Twitter).

Third, at least some in the White House appear to think that Yellen is too dovish and would lack credibility with markets. This is probably where White House sentiment and investors’ own views clash most strongly (and undoubtedly where Yellen and her supporters would vehemently disagree). Many investors see Yellen as the continuity candidate, and in any case believe that very easy policy is still called for. Summers, in contrast, could be highly disruptive because of his personal style and because his views on policy differ from the current Fed leadership. But if the White House has determined that Yellen is too dovish—and that Summers is at least dovish enough—this argument could weigh heavily on the decision, regardless of our own view of its merits.

Whatever the strength of their résumés, the facts in hand suggest the Fed Chair race is Summers’ to lose. The negative reaction to his candidacy has been surprisingly intense in the press and from certain corners of the Democratic party and this could affect Obama’s views on the pros and cons. We expect that the evolving politics around the decision will now drive the outcome more than anything else.

1This term is sometimes used in philosophy and psychology, though with a slightly different meaning.


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