By Robert Kuttner
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.
The less that budget austerity serves as a drag on recovery, the less the Fed needs to resort to monetary heroics. So a Fed led by Yellen could represent a better mix of monetary, fiscal and regulatory policy. She could also act as a salutary counterweight to the deficit hawks — since the Fed exercises influence on the economic policy debate beyond the Fed's own actions.
Yellen's views, presumably, are one reason why President Barack Obama hesitated to appoint her, since they are more expansive than those of his own economic team. But that team is dissipating.
Peter Orszag, who served as Office of Management and Budget director and was a highly influential voice of budget austerity, has departed to Wall Street — following Robert Rubin back to Citigroup. Of the original group of Rubinistas, who orchestrated financial deregulation during the Clinton administration, Gene Sperling has just stepped down as head of the National Economic Council. Sperling was one of the strongest voices advocating Summers' appointment. The new heads of OMB and the council are more technicians than power players.
Jason Furman, one of Rubin's closest protégés, is still on board, as chairman of the Council of Economic Advisers. As is Jack Lew, who has succeeded Tim Geithner as Treasury secretary.
But Sarah Bloom Raskin, now a Federal Reserve governor, was just appointed to the influential number two job at Treasury, and she will bring a somewhat different perspective. At the Fed, she served as the board's expert on housing policy — an area where existing programs have largely failed to solve the huge backlog of distressed mortgages. A former banking commissioner of Maryland, Raskin favors tough regulation.
In addition, today's budget politics are different from what they were in 2010, when Obama, prematurely as it turned out, pivoted from expansionary fiscal policies to deficit reduction. In 2010, he appointed the Bowles-Simpson Commission, which pressed in vain for a deficit-cutting formula but did influence public opinion in favor of budget cutting. In 2011, the president approved the Budget Control Act, and its deflationary spawn, the dreaded sequester.
Today, however, budget politics are dramatically different. The deficit is falling of its own accord — thanks to previous cuts and a modest recovery. Meanwhile, Republicans have become more strident in their demands. They are again threatening to shut down the government and to refuse to increase the debt ceiling unless the president agrees to defund his crown jewel, the Affordable Care Act.
But though they faced a very conciliatory Obama in 2011, this time looks to be different. The president says he is not negotiating further budget cuts in exchange for a debt ceiling increase — much less putting Obamacare on the chopping block.
If the Republicans want to shut down the government, the onus is now on them. That tactic did not work out so well for then-House Speaker Newt Gingrich, and the ghosts of 1996 have Speaker John Boehner (R-Ohio) squirming.
So a new Fed chairwoman could signal not just a different regime at our central bank, but a broadly different economic policy — loose money combined with tight regulation and a more balanced fiscal policy. All a change for the better.
(Robert Kuttner is a Reuters columnist. Opinions are his own.)