Ben Bernanke’s term as chairman of the Fed ends in January, and it is widely expected that he will not stay on. Speculation has recently heated up over as to who his successor will be.
The conventional wisdom is that current Vice Chairman Janet Yellen and former Treasury Secretary Lawrence Summers are the most likely possibilities, with former Vice Chairman Roger Ferguson as the dark horse. However, until two weeks ago, all the smart money was on Yellen. That has changed, particularly in the past couple of days, due to a pair of articles by Ben White and Ezra Klein referencing anonymous sources identifying Summers as the leading candidate.
What does the literature tell us about choosing the best Fed chair?
A mathematical model of the chairman’s leadership style
Where Yellen and Summers differ most is leadership style: Summers is taken to be more aggressive and outspoken. Summers is to Yellen as Alan Greenspan was to Bernanke. (Greenspan was a famously authoritarian chairman, whereas Bernanke is a consensus-builder.)
Petra Gerlach-Kristen, an economist at the Swiss National Bank, develops a simple model of a committee of monetary policymakers headed by a chairman.
The chairman can either be aggressive or democratic. The aggressive chairman is modeled as strategically suggesting an interest rate to pull the average opinion of the group closer to his ideal. The aggressive chairman, for example, proposes a 0.5 percentage point increase in the federal funds rate when he really wants a 0.25 percentage point increase if the majority of the committee supports no change in the rate.
The result of the model is that interest rate setting under an autocratic chairman, such as Summers, is worse than under a less autocratic one, such as Yellen.
It’s an interesting model, but the number of simplifying assumptions (e.g. an FOMC member only votes with chairman if the chairman’s preferred interest rate is within +/- 23 basis points of the member's preferred rate) required to build a model of the FOMC is too great to allow one to draw any real useful conclusions from it. The FOMC has 12 voting members, which is not small enough to be analyzed easily using game theory and not nearly large enough to be simplified as a large population. Not to mention that the motivations of voting members are multiple, complex, and varied.
An historical analysis
Christina and David Romer analyze the history of the Fed, combing through its minutes and transcripts, to tease out what makes a good chair in a paper titled simply “Choosing the Federal Reserve Chair: Lessons from History.”
Based on a review of the performance of past chairmen, they find (perhaps reassuringly?) that when choosing a Fed chair, “The key criterion should be economic beliefs.”
How then can economic beliefs be understood? Romer and Romer argue the most reliable evidence comes straight from the prospective candidate’s mouth: speeches, writing, and testimony are (again, perhaps reassuringly) reliable indicators of an economist’s beliefs.
Unfortunately this historical analysis is forced to rely on a tiny sample size, as the Fed has only had only six chairmen since gaining full independence from the Treasury in 1951.
Nonetheless, this suggests to me an alternative candidate who should be under consideration to be Bernanke’s successor: Christina Romer herself! Romer has written many great papers on the Great Depression, the Japanese Lost Decade, the operating procedure of the FOMC, and much more. Best of all, she is an avowed supporter of NGDP targeting.
This is also a major point against Summers, who, as Scott Sumner points out, failed to push for aggressive monetary expansion during the recession despite being a member of President Obama’s inner circle.
Time for a regime change
Lastly is the concept of a regime change. Numerous papers, particularly Eggertsson (2008), suggest that the US was able to escape the depths of the Great Depression because the election of Franklin Roosevelt was such a significant “regime change” that there was shock to expectations of future growth. This was a boost to confidence and spending, causing growth to return.
Could such a regime shift occur today with the appropriate appointment of a new chair? Certainly. Japan is currently going through a regime shift with the recent election of Shinzo Abe and the appointment of Haruhiko Kuroda to the Bank of Japan, as (there she is again!) Christina Romer (2013) discusses.
Who could create such a regime shift today? Not Yellen or Summers; they are almost the definition of mainstream. Romer might have a chance, especially if she pushed hard on NGDP targeting.
But if Obama wants to go for a regime shift, go big or go home. Many market monetarist economists – e.g. Scott Sumner, David Beckworth, Nick Rowe – would make great chairs in their own right, but also would create a shock to expectations. Not to mention that the market monetarist understanding of monetary policy is superior to other paradigms.
More on that as this blog continues.