President Obama's Big, Frothy Hint

President Obama, in an interview with the New York Times, said a few sentences about what he's looking for in the next Fed chair. A few newspapers, including the Washington Post, have already exclaimed that "President Barack Obama says his next Fed chairman should take ordinary people into account when setting monetary policy."

President Obama indeed mentions "the lives of ordinary Americans getting better." But taken in context, his remarks are surprisingly inflation-hawkish and relatively unconcerned with unemployment. He says:

And what I’m looking for is somebody who understands the Fed has a dual mandate, that that’s not just lip service; that it is very important to keep inflation in check, to keep our dollar sound, and to ensure stability in the markets. But the idea is not just to promote those things in the abstract. The idea is to promote those things in service of the lives of ordinary Americans getting better. And when unemployment is still too high, and long-term unemployment is still too high, and there’s still weak demand in a lot of industries, I want a Fed chairman that can step back and look at that objectively and say, let’s make sure that we’re growing the economy, but let’s also keep an eye on inflation, and if it starts eating up, if the markets start frothing up, let’s make sure that we’re not creating new bubbles.

When he says "The idea is to promote those things in service of the lives of ordinary Americans getting better," those things refers to keeping inflation in check, keeping the dollar sound, and ensuring stability in the markets. He's emphasizing the price stability part of the dual mandate much more than the maximum employment part. When he then goes on to mention high unemployment (a much bigger impediment to the lives of ordinary Americans getting better, in my opinion), he is remarkably quick to mention keeping an eye on inflation in the very same sentence.

The President says he wants "somebody who understands the Fed has a dual mandate," but somebody who truly understood this would recognize that the Fed's efforts in this economic environment should be focused on restoring full employment.

And then there are the remarks about frothing markets and bubbles. Now, President Obama refused to answer the NYT reporter's question about who he was considering for chairman--in particular, he refused to say whether he was planning to appoint Larry Summers--but this is a pretty big hint. Fed officials are split over the appropriate role of the Fed in trying to identify and constrain asset bubbles. The so-called "Bernanke doctrine" holds that monetary policy should be used to deal with normal macroeconomic concerns, while regulatory policies should be used to try to alleviate financial imbalances. Ben Bernanke, of course, is a follower of the Bernanke doctrine, as are, among others, Governor Sarah Raskin and Vice Chairwoman Janet Yellen. Yellen, a top contender for the next Fed chair, has said, "I think most central bankers view monetary policy as a blunt tool for addressing financial stability concerns and many probably share my own strong preference to rely on micro- and macroprudential supervision and regulation as the main line of defense."

Governors Jeremy Stein and James Bullard are among the group who don't buy the Bernanke doctrine; they believe that monetary policy (i.e. higher interest rates) should be used to "fight financial excess a little more than we have in the last few years." Larry Summers, also considered a top contender, fits more into this group, expressing concerns that the Fed's monetary policy of recent years creates "an environment that’s going to increase the risk of – going to increase the risk of bubbles."

So I think President Obama's comment, "if the markets start frothing up, let’s make sure that we’re not creating new bubbles," reveals who has his ear, and maybe whom he has in mind: Summers.

But returning to "the lives of ordinary Americans getting better," here's Janet Yellen in 1995:

"I began by asking myself the question, what is it that the public cares about? The answer seems straightforward to me. It is not just high and variable inflation; that is not the only aspect of economic performance people care about. The public also cares about real outcomes. Households and businesses very much dislike fluctuations in output and employment, for good reasons. Quite naturally, they prefer higher average output and lower average unemployment. I consider these goals eminently sensible, not foolish nor irrational. 

Then I ask myself, what is it that the Fed can accomplish? I conclude that the actions of this Committee affect not just the level and variability of inflation but also at a minimum the variability of output and employment. I know that some people would argue against our trying to reduce the variability of output on the grounds that economic forecasting is so uncertain and that there are long and variable lags in monetary policy, so maybe all we would do is to destabilize the economy rather than stabilize it. But when I look at the record, I just do not agree. It seems to me the record shows that within limits, tuning works even if it is not "fine."... 

The moral I draw is simply that the Fed should pursue multiple goals. It follows almost automatically that when the American people have sensible multiple goals and the Federal Reserve affects multiple dimensions of economic performance, that the Federal Reserve Act should enshrine all of those goals and we should do our best to honor them... I understand that the mandate of the Federal Reserve Act to pursue multiple goals is pretty vague. There really is no guidance in the Act as to how to call the tough trade-offs. But I see the objectives as fundamentally sound, and I think this Fed, in pursuing those goals, has enhanced social welfare...I want at least to mention that if this Committee were to decide that it really wanted a quantitative monetary policy rule incorporating a numerical inflation target--for example, because it was thought to be important to have a nominal anchor for monetary policy--we should not go with the type of rule embodied in the Neal amendment, which is a pure inflation targeting scheme. Why? Because there clearly are better rules. We could talk about those at length but a simple approach, not necessarily the best, that dominates inflation targeting would be a hybrid rule that would adjust monetary policy--and this could be a mechanical rule if it were so desired--on the basis of two gaps, not one. These would be the gap between actual and target inflation and also the gap between actual and potential output...Uncertainty about sales impedes business planning and could harm capital formation just as much as uncertainty about inflation can create uncertainty about relative prices and harm business planning."

She got it then and she gets it now. I could say more about her remarkable credentials, but plenty of people have already jumped in to do so in the last week. I can only echo that she is the best choice to replace Chairman Ben Bernanke at the Fed.

***Fun fact: My high school, like most high schools, voted on "senior superlatives" (most likely to succeed, best athlete, etc.) Oddly, I was given "Most likely to be the next Alan Greenspan." I say oddly because I had no interest in economics at the time, and still didn't for another few years after that. Obviously, I did not become the next Alan Greenspan. Ben Bernanke beat me to it! But I was still tickled by Binyamin Appelbaum and Annie Lowrey's remark that "President Obama’s choice of a replacement for the Federal Reserve chairman, Ben S. Bernanke, is coming down to a battle between the California girls and the Rubin boys," and to have the great pleasure of being associated with the California girls!