The $4 Trillion Choice: Why the Stakes Are So High for Next Fed Chair

President Obama is mulling what could well be the most important decision of his second term – nominating Ben Bernanke’s replacement as Federal Reserve chairman.

Bernanke, whose second four-year term is set to end in January, has presided over perhaps the most dramatic period in the century-long history of the Fed, the mostly autonomous central bank that sets interest rates and controls the supply of money for the U.S. economy.

The credit crisis that emerged in late 2007 with a downturn in the housing market eventually led to a near-collapse of the financial system and the deepest economic recession since the Great Depression.
In response, Bernanke drove the short-term interest rates under its control to near zero, and unleashed three rounds of bond buying that have injected massive amounts of fresh money into the economy to keep inexpensive loans flowing in the economy.
The economic recovery, while slower than hoped, has continued since late 2009, and Bernanke has vowed to keep rates unusually low at least until the unemployment rate, now at 7.4%, falls to 6.5%.
The stakes surrounding Obama’s choice for Bernanke’s successor are unusually high. For one thing, the Fed chairmanship doesn’t frequently become vacant. Since 1979, there have been only three leaders of the Fed.

Paul Volcker was put forward by President Jimmy Carter and is credited with slaying runaway inflation and setting the scene for the ‘80s economic renaissance through punitively high interest rates. Alan Greenspan used opportunistic rate cuts to help the eoconmy through the 1987 stock-market crash and 1990 recession, ushering in the ‘90s boom.
Bernanke has also presided over an unusually aggressive stimulus policy, which continues for the moment in the form of $85 billion of Fed purchases of Treasury and mortgage bonds per month. His programs have ballooned the Fed’s assets to nearly $4 trillion from less than $1 trillion before the financial crisis.
At some point, Fed stimulus must be wound down in response to further economic improvement, or perhaps a pickup in inflation. At the moment, financial markets are nervously watching for clues of the Fed’s intentions for dialing back its “quantitative easing” campaign of monthly bond purchases – with many economists expecting this to occur in September.
The new Fed chair will have to manage this process, while also assuring world investors, consumers and businesspeople that he or she stands ready to respond assertively to changing economic fortunes. With interest rates around the developed world already close to zero, central bankers’ spoken messages about future policy carry enormous weight.
The two presumed frontrunners for the Fed nomination are Lawrence Summers, Treasury Secretary under President Clinton and Obama’s first National Economic Advisor, and Janet Yellen, current Federal Reserve Vice Chair.

The choice has been unusually contentious, in part because of the way Obama touched off the succession race by seeming to declare in an interview the end of Bernanke’s tenure before the Fed chief himself did, and months before the end of his term. The contrasting personalities of Summers and Yellen, and the strong feelings voiced by their respective supporters, have also made the nomination process more intense. The White House has also not ruled out other dark-horse contenders.
Few question the economic aptitude or policymaking experience of either candidate. Both have been broadly supportive of Bernanke’s policies, though Yellen is generally viewed to be more apt to lean toward greater economic stimulus and less concerned with potential inflationary risks.
Summers is almost universally considered intellectually brilliant but tactless and abrasive, perhaps more prone to impulsive public comments. He famously alienated the Harvard faculty while he was university president with some musings over whether women might lack some capacity to excel in the upper reaches of the sciences.

Yellen is widely liked in Washington and the economics profession, respected for her research work and was shown by The Wall Street Journal recently to be the most accurate economic forecaster among Fed policy officials. Somewhat professorial in manner, she has drawn the support of many female legislators who believe she would make an excellent choice as the first woman Fed chief.
While both seem qualified and have their strong advocates, whomever Obama chooses will certainly face a tough Senate confirmation fight – another indication of how high the stakes are.