Lawrence Summers, then Director of the National Economic Council yawns during a session at the World Economic Forum (WEF) in Davos, January 30, 2010.
Economists at BNP Paribas have issued a research note saying if President Obama picks Larry Summers as the next Federal Reserve Chairman, he will do serious harm to the U.S. economy.
Julia Coronado, Chief Economist for North America at BNP, and her colleagues Bricklin Dwyer and Laura Rosner estimated in a note last week that picking Summers over Fed Vice Chair Janet Yellen would shave 0.5 to 0.75 points off GDP growth over two years and cut job creation by 350,000 to 500,000 jobs.
Here’s their argument:
- Summers is, in fact, more hawkish on monetary policy than Yellen, and will be inclined to pull back earlier and faster on quantitative easing. “Summers has been active on the speakers circuit and has expressed views on monetary policy that are notably more hawkish than those of Chairman Bernanke or Vice Chair Yellen. Summers has said US QE is not particularly effective in supporting the real economy, that Japanese QE is 2-3 times more effective than the US version, that monetary policy will tighten sooner in the US than many currently think, and that a lot of money will probably be made shorting bonds over the next five years.”
- And if he wants a tighter monetary policy, he'll push for it, even if he faces resistance. “He has a reputation for coming into positions of institutional leadership and trying to implement significant changes… he does not have a track record that speaks to continuity and consensus building.”
- Even before Summers comes into power, long-term Treasury yields will rise in anticipation of his future actions. The authors anticipate that Summers’ confirmation process could drag into the spring. Until then, the Fed’s ability to hold down long-term rates through forward guidance would be diminished, because the expectation of Summers-driven policy change would make that guidance less credible.
- In fact, 10-year Treasury rates have already risen because of the expectation that Summers will be nominated. The authors estimate that Summers-mania has added 30 basis points (0.30%) to 10-year Treasury yields. They arrived at this conclusion by looking at how Treasury yields have moved as forecasting markets have become more convinced that Summers will be the nominee.
- If Summers is chosen, 10-year Treasury yields will be about 50 basis points higher over the next few years than if Yellen is picked. Under Yellen, markets would have more confidence that the Fed would exit QE slowly and the Fed would actually exit more slowly. The authors actually expect 10-year yields to fall by about 30 bps in the event of a Yellen announcement before gradually rising again.
- Higher interest rates mean slower economic growth and less job creation. Under normal circumstances, the effects of a 50 bp increase in 10-year rates would be really big: cutting GDP growth by about 1.5 percentage points over two years and costing about a million jobs.
- Because of special current economic circumstances, the costs of higher rates are smaller, but still significant: 0.5-0.75% off GDP growth over two years and 350,000 to 500,000 jobs lost. The authors actually agree with Summers that the still-tight credit markets mean low rates don’t boost the economy today as much as they normally would. (This is why Summers isn’t keen on QE.) But they still think the impacts would be major, despite the muting.
Coronado and her colleagues end with this sobering observation (emphasis mine):
The bottom line is that the policy uncertainty introduced by a Larry Summers candidacy would likely come with an economic price tag in terms of market stability and growth. Nonetheless, the efficacy of monetary policy does not seem to be the driving force in this nomination process and the forces in Washington seem to be moving in the direction of a Summers nomination.
That part, I think, is not totally right. Yes, there are major non-monetary factors driving this decision: Obama appears to be driven in part by his desire to install a close and trusted advisor at the Federal Reserve, regardless of policy specifics. And many of Summers’ critics from the left are more focused on bank regulation issues and his past comments on women in science than they are on monetary policy.
But Summers also appears to align more than Yellen with the president’s own hawkish monetary policy instincts. When the New York Times asked Obama back in July what he was looking for in a Fed chair, his remarks focused heavily on controlling inflation and preventing bubbles.
The president likely shares Coronado’s view that Summers would be more hawkish on monetary policy than Yellen. But he probably sees that as a feature, not a bug.
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