What does Larry Summers really think of QE?

Abby McCloskey Program Director for Economic Policy Studies, American Enterprise Institute
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Rumors abound that Larry Summers could be the next chairman of the Federal Reserve. Why? What advantages does he have over the front-runner, current Fed Vice Chair Janet Yellen? Summers’ allies say he is the only one bold enough to stop inflation in its tracks, a feared outcome of quantitative easing, the Fed’s ongoing policy of expanding the money supply.

But it’s unclear what Summers would actually do as Fed chair. He has refused to comment on QE entirely over the last few months, “tap-dancing” around the issue on a June 4th panel with the Wall Street Journal’s Gerald Seib and David Wessel.

With Summers revealing little, probably on purpose, one must deduce his true views on QE. There are three possible approaches he could bring to the Federal Reserve, each with dramatically different implications for monetary policy.

Summers the Keynesian: QE exacerbated

Throughout his academic and public career, Summers generally has supported traditional Keynesian economics, which prescribes expansionary fiscal and monetary policy during an economic downturn. The downward revision of first quarter GDP, slowdown in China, continuing crisis in the Eurozone, and decline in inflation projections make it difficult to imagine a Keynesian economist such as Summers pulling back on QE right now.

It is easier to imagine him pushing ahead to jolt the economy out of its malaise, especially if inflation stays low. Keeping interest rates near zero for longer also would provide fertile ground for one of Summers’ favorite policy prescriptions — more shovel-ready projects.

According to his research with Brad DeLong, fiscal stimulus has the biggest impact at the zero bound. Presumably, Summers could keep the easy money flowing until his comrades in the administration or Congress pass another stimulus package.

More stimulus! Not popular with most Americans.

Summers the politician: QE unchanged

There is a much stronger case that Summers leaves QE unchanged to avoid crashing the market during President Obama’s second term.

The QE debate has been all over the place, and the market has responded to the uncertainty. As a seasoned politician, Summers recognizes the negative way this policy uncertainty reflects on leadership. He is likely to go to great lengths to reduce uncertainty and negative attention for the administration, which would probably include keeping QE flowing. “A valid case for low inflation must have to do with the inefficiencies caused by allowing the monetary standard to vary,” he said in a 1991 panel.

Thus, it is possible, and even extremely likely, that Summers would continue the Federal Reserve’s current policies. His allegedly “hawkish” advantage is overstated — this would be the best possible outcome of a Summers chairmanship.

Summers the heavy-weight: QE tapered

Down the road, holding back inflation will be a major responsibility of the Fed. This very scenario is the reason why Summers is believed by some to be the preferred candidate. But be careful what you wish for. It will be difficult enough exiting QE. Summers’ views and the markets’ fragile condition could make it a disaster.

Soft-spoken Chairman Bernanke has rattled the markets just by talking about tapering. On June 20, the markets had their biggest one-day point drop since September 2011. Bond yields rose to a 22-month high. The market volatility revealed beyond a shadow of doubt just how hooked on QE markets have become. It will take an extremely delicate touch to avoid market panic when tapering actually begins, something Summers is not known for.

Additionally, the Fed chairman needs to be a consensus builder within the Federal Open Market Committee, and Summers (unless he’s a changed man) is notoriously difficult to work with. The trend of Federal Reserve Governors voicing their differences with the QE policy would likely become even more commonplace under a Summers chairmanship, dramatically increasing policy uncertainty and resulting in economic drag.

The Financial Times’ Edward Luce acknowledges and pooh-poos Summers’ lack of charm. Being Federal Reserve chairman is very much a global communications position. Recent evidence shows tact will be critical in calming the markets and presenting a unified front at the Fed. We need someone strong enough to tame inflation — not to kill it and scare the markets.

Which approach would Summers adopt as Fed chair? It is anyone’s guess. If Summers seriously is considering being chairman, I recommend he take his case to the public as soon as possible, providing a clear statement on how he would approach QE and monetary policy writ large.

Absent that, there’s too much uncertainty around Summers’ main selling-point to bypass the front-runner.

Abby McCloskey is the program director of economic policy studies at the American Enterprise Institute.