“How many central bankers does it take to screw in a light bulb?” went a joke of the late 1990s. “One,” the answer went: “Greenspan holds the bulb and the world revolves around him.” It was the pre-populist era, when experts and technocrats were celebrated, and Alan Greenspan, the Fed chairman, was the ultimate empowered guru. By quiet force of intellect, Greenspan seemed to control financial markets and the world economy. Bill Clinton used to joke that the Federal Reserve chairman was more powerful than the president himself.
Today, as President Trump ponders his choice for the next Fed chairman, central banks have lost their superhero aura. For one thing, the Trump team can't be bothered to fill some of the top Fed positions: Three of seven seats on the Fed's board of governors stand vacant. But the more serious problem is that central bankers are experiencing a crisis of intellectual confidence unlike any since the double-digit inflation of the 1970s. Even a year or two ago, they thought they understood their mission. Now they are not sure.
The crisis begins with the strange behavior of inflation, which has languished below the Fed's 2 percent target almost continuously for nine years. After the 2008 mortgage bust, this "lowflation" was unsurprising: Unemployment hit 10 percent, so employers could hire all the workers they wanted without raising wages. Today, unemployment stands at 4.2 percent, the lowest since 2000. Perplexingly, the Fed's favorite measure of inflation remains at a rock bottom 1.4 percent.
Why is this a problem? Since the mid 1990s, the Fed has believed that, if it targeted inflation, most other things in the economy would take care of themselves. Steady inflation of 2 percent meant that employment and the use of productive capacity more generally were at sustainable levels: neither unnecessarily low, which would imply painful joblessness, nor awkwardly high, which would cause bottlenecks.
Today's puzzling price stability undermines the faith that inflation is a reliable proxy for wider economic stability. According to the inflation-targeting doctrine, low inflation should signal underutilized industrial capacity and high unemployment — but right now, it does not. In a speech last month, Janet Yellen, whose term as Fed chair expires in early February, held out the hope that this was a temporary aberration. But she also confessed that she and her colleagues might have misunderstood "the fundamental forces driving inflation." We could be approaching a 1982-style watershed — the moment when the Fed admitted that another over-simple target, the money supply, was not an adequate proxy for stability writ large.
If inflation pressures have mysteriously abated, can't the Fed just celebrate by keeping interest rates low and enjoying the consequent growth? Some commentators make precisely this argument, but even Ben Bernanke, former Fed chairman and leading proponent of inflation targeting, has begun to express doubts about this doctrine, as my colleague Robert J. Samuelson has noted. Increasingly, the majority view (including Yellen's) is that sticking with rock-bottom rates in the face of decent growth and full employment may be asking for trouble.
What sort of trouble? The central bankers dance around this question, but the most obvious risk is that excessively low interest rates will inflate a financial bubble. In her speech, Yellen allowed that low borrowing costs could lead — guess what! — to excess Wall Street borrowing, though on Sunday she declared that financial stability risks remained "moderate." The view of sober investors is closer to Yellen's first one. Last week Frank Brosens, the head of Taconic Capital, a hedge fund, enumerated the ways in which years of low interest rates have bred market complacency, setting the system up for a potential fall.
How does this central-bank uncertainty relate to the choice of Fed chairman? The White House should want someone who is open to the view that inflation-targeting has reached the end of its usefulness, and who accepts that the largest threat to stable growth and employment comes from the risk of a financial bust. In raising interest rates despite below-target inflation, Yellen has shown at least a tentative openness to rethinking a tired doctrine. Even though I have argued that she ought to be raising rates less predictably, since uncertainty is a healthy antidote to Wall Street complacency, reappointing her to a second term would be the prudent choice.
If the administration is determined to appoint somebody different, who then? The candidate who stands out is Kevin Warsh, a former Wall Streeter, Fed governor and long-time skeptic of Fed actions that threaten to dull markets' sense of risk. Warsh has been faulted for his skepticism of the Fed's quantitative easing and his mistimed concerns about inflation; as the transcript of Fed deliberations in November 2010 shows, these criticisms are right. But that same transcript also contains statements that needed to be stated. "Finance, money and credit curiously are at the fringe of the Fed's dominant models and deliberations," Warsh said. "That must change, because booms and busts take the central bank farthest afield from its objectives."
At a time when the Fed needs to shift from inflation targeting to a greater cognizance of bubbles, Warsh’s feel for finance is a strength. Because his term as governor coincided with the collapse of Lehman Brothers, Warsh is the candidate with the most crisis-fighting experience. And, perhaps because he comes from Wall Street, he is the candidate most likely to battle its complacent side.
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