The Next Battle at the Fed

AP Images/Pablo Martinez Monsivais

With the Administration’s stunning decision to name Janet Yellen to chair the Federal Reserve, at least one major government institution will weigh in strongly on the side of economic recovery, right?

Well, maybe.

First, of course, Yellen has to be confirmed. That, thankfully, seems a good bet.

But there is also the problem of three vacancies on the seven-member Fed Board of Governors, which President Obama will soon fill.

If the wrong people are appointed to these jobs, Yellen’s ability to aggressively use low interest rates to strengthen the recovery will be destroyed. But why would Obama do that?

The Treasury and Wall Street crowd who dearly wanted Larry Summers rather than Yellen will now be focusing on the three other seats. If they can’t get their man in as chair, at least they can narrow the options of the woman who got the job. The same insiders who pressed Obama to go out on a limb for Summers will be pushing hard for Wall-Street-friendly nominees for the other posts.

With the Yellen nomination controversial among conservatives, safe and orthodox appointees for the other slots would be balm for the usual suspects. While the position of chair was a high-profile argument within the Democratic Party that progressives won, the other seats on the Fed’s governing board fly well below the radar.

The Fed, with Yellen’s strong support, has relied on an innovative program of bond purchases, known in the jargon as “Quantitative Easing,” to keep interest rates low. This policy has lowered credit costs throughout the economy, offsetting the depressive fiscal policy of deficit reduction. Some in the financial industry like this policy because it’s good for the stock and bond market. Others fear that it courts inflation. But most on Wall Street and in positions of power in the Administration want other Fed governors more orthodox than Yellen.

There is also a close, if seldom appreciated, connection between the low interest rates that Yellen supports and the equally contentious issue of tougher financial regulation. The weaker the financial regulation, the greater is the risk that easy money promotes financial bubbles. Conversely, if we have tough regulation against speculative excess, including high capital standards for banks, we can have the low interest rates that the rest of the economy needs. But the orthodox view is that it’s time to end the policy of very low interest rates, and that we don’t really need tougher regulation.

Consider the case of Fed Governor Jeremy Stein, a former Harvard economist who had served at the Treasury and on the National Economic Council under Tim Geithner and Larry Summers.

Stein has emerged as the most influential inside critic of the Fed’s low interest rate policy, calling for an early end to Quantitative Easing as well as automatic triggers (shades of Milton Friedman!) that would end the bond purchase program when certain benchmarks were hit. He has lobbied for this policy change inside the Fed, and in his many speeches.

It was partly Stein’s pressure last summer that helped push the official statements of the Fed’s Open Market Committee to hint that the low interest policy might end as early as this fall, which in turn caused bond markets to bid up interest rates in anticipation of the policy shift.

Who appointed this man? Barack Obama. Why? Because he listened to advisers at the Treasury, the National Economic Council, and on Wall Street.

So unless the same progressive community that demanded and got Janet Yellen as chair are equally vigilant on the three other vacancies, the more orthodox approach of Stein could command a majority of Fed seats.

Back when the Yellen-Summers fight was still at a rolling boil, the White House leaked the name of Lael Brainard as a likely appointee to the Fed. Brainard, the highest ranking woman at the Treasury, serves as undersecretary for international economic affairs. She was tapped for a Fed seat back when the Administration was eager to put forward a prominent female, to counter outrage that the president was hoping to pass over Yellen in favor of Summers. But more to the point, Brainard is yet another protégé of Summers, Geithner and their mentor, Robert Rubin.

When the stars are in perfect alignment, as they were in the Yellen-Summers imbroglio, occasionally the progressive wins. But generally, the structural forces are all on the other side.

So, gentle reader, keep an eye on those other Fed seats. Otherwise, on the issues that matter, Yellen could be chair in name only.

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