Opinion

The Great Debate

Yellen: An economic tonic for the sluggish recovery

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.

However, a different regime at the Fed, most likely under Yellen, could offer an economic tonic more subtle and healthful than just cheap money.

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.

‘Democratic wing’ of Democratic Party takes on Wall Street

The chattering classes are fascinated by the Republicans’ internecine battle to redefine the party in the wake of the George W. Bush calamity and the Mitt Romney defeat — from Senator Rand Paul’s revolt against the neoconservative foreign policy, to intellectuals flirting with “libertarian populism.” Less attention has been paid, however, to the stirrings of what Senator Paul Wellstone dubbed “the Democratic wing of the Democratic Party” — now beginning to challenge the Wall Street wing of the party.

Perhaps the strongest demonstration of this was the barrage of “friendly fire” that greeted the White House’s trial balloon on nominating Lawrence Summers to head the Federal Reserve Bank. More than one-third of Democrats in the Senate signed a letter supporting Janet Yellen, now vice chairwoman of the Fed. More than half of the elected Democratic women in the House of Representatives signed a similar letter. Many were appalled at the notion of passing over the superbly qualified Yellen for Summers, with his notorious record of denigrating and dismissing women.

But, as Katrina vanden Heuvel, editor of the Nation wrote in the Washington Post, Summers also drew opposition because he was the “poster boy for the Wall Street wing of the party — literally.” (Summers joined then-Treasury Secretary Robert Rubin and then-Federal Reserve Chairman Alan Greenspan on the now risible 1999 Time magazine cover celebrating the “Committee to Save the World” — before the global financial collapse exposed the folly of their policies).

Larry Summers is playing economic Jeopardy

Editor’s note: This op-ed was originally published at the Financial Times in response to the recent piece by Lawrence Summers for Reuters. It has been republished, verbatim, with the FT‘s permission.

Larry Summers’ considerable intellect suggests that he would be an excellent contestant on the popular game show Jeopardy. Of course, on the show, the question offered by the contestant must match the answer on the board. Summers and I disagree on the answer that matches the question “What is President Obama’s budget?” Let’s see why.

I asked two questions in an op-ed in Wednesday’s Wall Street Journal. (Neither question was addressed by Mr Summers, or in the simultaneous parallel critiques offered on the airwaves by US Treasury Secretary Timothy Geithner and former Council of Economic Advisers Chairman Austan Goolsbee). The first question was whether the tax increases on high-income individuals proposed by President Obama (the Buffett rule, higher taxes on dividends and capital gains, a higher top marginal rate, and so on) raised enough revenue to materially offset the country’s large budget gap or higher federal spending under President Obama. The answer, using revenue estimates from the Treasury Department and spending estimates from the President’s budget is ‘No’. The second question was what that spending growth implied for future tax rates. That is, if federal spending as a share of gross domestic product was to increase permanently as the president proposes, by how much would taxes need to rise? Answer: a lot and for everyone. This simple thought experiment presumes that we will not ratify permanently larger deficits.

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By Robert H. Frank
The opinions expressed are his own.

Reuters invited leading economists to reply to Lawrence Summers’ op-ed on his reaction to the debt ceiling deal. We will be publishing the responses here. Below is Franks’s reply. Here are responses from Laura Tyson, Benn Steil, Russ Roberts, Donald Boudreaux and James Pethokoukis as well.

I’m in general agreement with Larry Summers’ piece. If it had been my column to write, I’d have been more emphatic about how much more important the unemployment problem is than the deficit problem. Deficits need to be reduced, yes, but not in the midst of a deep downturn. If we could put just half of the people who are either unemployed or underemployed back to work, for example, national income would be larger by more than ten times the interest we’re paying on the 2011 deficit. The extra income tax revenue alone would be enough to cover the interest on last year’s debt.

I’d also have hit harder on the claim by ostensible deficit hawks that extra spending right now would impoverish our grandchildren. Some of the most vivid and easily understood counterexamples involve infrastructure maintenance. According to the Nevada Department of Transportation, repairing a damaged 10-mile stretch of Interstate 80 would cost $6 million if we did the work today. But if we postpone repairs, weather and traffic will continue to damage the roadbed. If we wait just two years, the cost of bringing that same stretch of road up to par rises to $30 million. There are thousands of similar projects crying out to be done.

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