Here’s what Larry Summers would do at the Fed

September 4, 2013

Larry Summers is thinking about the Fed. (Chip Somodevilla/Getty Images)

With it looking increasingly likely that Larry Summers will be the next Fed chairman, there's been a lot of concern that he hasn't said all that much about monetary policy, and what he has said has sounded a bit hawkish. That scares investors who are already worried about the Fed beginning the long process of winding down the extraordinary support it's given to the economy in recent years.

As part of a story I wrote about why President Obama appears to support Summers despite all the outside criticism, I learned a bit about the approach Summers would likely take at the Fed, 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.

– Summers wouldn’t be any more dovish or hawkish than Ben Bernanke. He’d likely hold rates near zero for several more years, as the Fed currently says it would do. Given his deep concerns about the labor market, his bias would be to keep the central bank working aggressively toward reducing unemployment, as it is today. He’s a supporter of the Fed’s new employment and inflation thresholds, which say the Fed would allow inflation to rise just a tad above its 2 percent target – as far as 2.5 percent – as long as unemployment remains above 6.5 percent.

 – Summers won’t have a big effect either way on the Fed’s taper. Many investors might wonder whether he’d speed up the “taper,” the Fed’s exit from its asset-purchase programs. But the question isn’t that relevant. Summers would take over the Fed in February, and Bernanke himself has said the bond programs, known as quantitative easing, are likely to end by mid-2014.

– While Summers is somewhat skeptical about QE, that has little practical import. Summers has said he doesn’t think QE has much of an effect either positively or negatively on economic growth. But given how symbolically important it’s become – with a great effect on market psychology – he’s unlikely to come in and dramatically change the Fed’s approach to managing its balance sheet.

– Summers would look well beyond the unemployment rate to measure the health of the labor market. In the White House, Summers became obsessed with a scary fact: Even after the unemployment rate – which captures the percentage of Americans “seeking” work – falls back to the normal levels, the percentage of the population employed  is likely to remain very low. That’s because so many workers, lacking the skills to get good jobs, will give up.

– 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. Summers is the author of a seminal paper saying the political independence of the Fed is a crucial tool to preserve the central bank’s credibility in keeping inflation low, and he'd likely move swiftly to stem inflation if it began to rear its head.

– Summers would think more about what the Fed can do to stop financial bubbles, but he’d be more likely to address those concerns through regulation. Some have expressed concerns that Summers might increase interest rates to pop bubbles. But he’s more likely to crack down on major banks and financial institutions and demand they reduce their risk taking rather than try to use the blunt tool of interest rates.

– If a crisis did occur, he’d be no-holds-barred. Bailouts and aggressive intervention by the Fed became very unpopular in the wake of the financial crisis, now five years old. But whether the crisis is at home or abroad, Summers would be unflinching in using every tool at his disposal to try to provide relief or stability to markets.

– He thinks capital is king. Before the financial crisis, he wrote that that “a critical element of regulatory policy should be insisting on increased capital in existing financial institutions." There's every reason to believe he still believes in the primacy of demanding that financial institutions in the U.S. and abroad hold an excess of capital to buffer against shocks.

– He would use the Fed to pressure global banks to be more transparent and accurate. Summers has expressed skepticism that foreign banks accurately value their assets. He’d favor increase use of stress tests and better global accounting standards to reduce the risk of a foreign financial crisis that could reach U.S. shores.

 – He'd try to use the Fed's control of the guts of the financial system to help lower- and middle-class Americans. Little-understood is that the Fed has vast powers over how the financial system works – credit standards, check-clearing systems, community lending. In the past, Summers has expressed concerns that credit-worthy, working class Americans are not getting fair access to loans. He's also worried that banks may be not be offering basic, affordable financial services to the poor, forcing them to go to expensive check-clearing facilities and the like – all issues he'd probably try to address.

Zachary A. Goldfarb is policy editor at The Washington Post.
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