When President Barack Obama let it slip in a June interview that Federal Reserve (Fed) Chairman Ben Bernanke had “already stayed a lot longer than he wanted or he was supposed to,” the quest for the next Fed chair was underway. But few anticipated it would devolve into a fairly brutal brawl - by economist standards - between two extremely competent and capable PhD candidates: Fed Vice Chair Janet Yellen and former Treasury Secretary Larry Summers, who also served as Harvard’s president and chief White House economic advisor.
Both PhD economists are accomplished academics and well-respected policy practitioners. Ideologically, both are solidly Keynesian — they believe the weak economy is underpinned by weak demand and government can support growth through monetary and fiscal policy. Dr. Summers happens to believe that fiscal policy could have a stronger impact on demand. Both candidates appreciate, but are relatively sanguine about, the current upside risks to inflation.
Making a mountain out of a molehill
Philosophical differences do exist between Dr. Yellen and Dr. Summers, mainly in their assessment of how effective quantitative easing (QE) has been. Speculation is that Dr. Summers would likely be more “hawkish” — quicker to tighten monetary policy and raise interest rates — than his counterpart. But even by the strictest economic definition, he could at best be described as the hawkish wing of a monetary dove.
However tangible these relatively innocuous differences are, they’ve been magnified to the point where the two candidates appear to stand at the opposite ends of an ideological gulf. More disconcerting is this question: Why has what could be — and should be — a thoughtful, intelligent conversation about Fed leadership and monetary policy become overshadowed by undertones and innuendos of sexism, bullyism and cronyism?
No Fed nomination expected before fall
This battle is likely to be waged in the public arena for a while, if Chairman Bernanke’s confirmation process for a second term is an indication — from August 2009 to January 2010. President Obama’s appointment announcement of the next Fed chair — expected sometime in the fall between Labor Day and Thanksgiving — would be followed by several weeks of consultations on Capitol Hill before hearings and a vote by the Senate Banking Committee. Final confirmation would follow debate and a vote by the full Senate.
Why does this battle matter to investors?
The economic recovery is still on shaky ground, with market sentiment dependent on the latest data release and Fed statement. Against this background, the Fed chairman plays the very prominent role of navigating the choppy economic seas. Just the mention of “tapering” — or reducing the amount of Fed asset purchases — by Chairman Bernanke sparked sharp selloffs in equity, fixed income and emerging markets in May.
Should Dr. Summers be nominated — given his previous comments about QE’s limited effectiveness — the expectation is that the Fed’s monetary easing will end much sooner than the market expects, leading to higher interest rates and possibly a near-term selloff in fixed income markets. But both he and Dr. Yellen would likely tread carefully when it comes to ending unconventional monetary policy. No doubt both are acutely aware of and prepared to respond to economic shocks — whether inflation or contraction — to help keep growth on track.
Economic policy, management and communication
As we’ve observed throughout Chairman Bernanke’s sometimes controversial terms, the Fed chairmanship involves more than just economic policy. It also requires fostering a collegial environment among 19 opinionated Fed governors and finessing consensus. In addition, the chair represents Fed policy to a public demanding transparency and open communication.
It’s in these areas of management and communication style that differences between the two candidates are most clearly drawn, and those differences may have subtle implications for Fed policy and the economy more broadly. But in coming years, the Fed faces the onerous task of transitioning back to conventional monetary policy without sparking inflation or derailing the recovery. Since both candidates are equally capable of leading this undertaking — and given the gravity of the task — why does this battle have to be so ugly?
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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