The money markets rejoiced when Larry Summers pulled out of the race to be Federal Reserve chairman. The reason was simple, self-serving and not necessarily wholesome: A different chairwoman — most likely Janet Yellen — would be more inclined to continue the Fed’s program of large-scale bond purchases and low interest rates.
Stock and bond markets, of course, love low interest rates. Cheap rates on bonds push stock values up as investors seek higher returns. Interest rates and bond prices move inversely — so cheap money keeps bond prices high. And low interest rates are good for mortgage demand and housing prices.
But low interest rates, in the absence of offsetting regulatory policies, can also create financial bubbles — as we all learned the hard way in the run-up to the financial collapse of 2008. For some critics, the Fed’s current low interest rates are now creating bubble conditions in foreign exchange and other speculative markets.
Yellen, who has served as vice chairwoman of the Fed since 2010 and worked closely with Chairman Ben Bernanke, would represent an intensification of Bernanke’s policies in several constructive respects. She is not only even more supportive of using monetary expansion to promote recovery, she favors tougher financial regulation as an antidote to speculative bubbles. Yellen has also been critical of the perverse elixir of deficit reduction as the cure for a sluggish recovery.