President Barack Obama is making the most important economic-policy decision of his second term: picking a new chairman for the Federal Reserve. We shouldn't be optimistic, because nothing the president has said or done suggests that he is at all displeased with a Fed performance that has been just short of disastrous.
Tight money by the Fed was a major cause, and maybe the major cause, of the financial crash. Its officials spent the summer of 2008 worrying about the nonexistent threat of inflation, and their first monetary-policy decision after Lehman Brothers Holdings collapsed was to discourage bank lending, a contractionary step. They let the economy's total spending level fall at the fastest rate since the Great Depression.
Since the economy hit bottom, spending has risen slowly and recovered no lost ground. The demand for money balances remains higher than normal, a symptom of continued tightness.
For five years, inflation and inflation expectations have consistently been below the Fed's target, and unemployment has been above it. Fed policy — set by a board of governors that now includes six Obama appointees among its seven members — has therefore been too tight, and its attempts at loosening have been insufficient.
When he took office, Obama was convinced, according to his former adviser Christina Romer, that monetary policy had done all it could: that with interest rates near zero, the Fed couldn't loosen any further. This wasn't true. Raising the inflation target, depreciating the dollar, doing more quantitative easing — there were many ways a determined Fed could have reflated the economy. And the central bank would, in fact, go on to do more quantitative easing later in Obama's first term.
Obama didn't make it a priority, obviously, to put people at the Fed who would make money looser. He let vacancies continue without nominating replacements even when he had 60 Democrats in the Senate to get them confirmed. When the Fed's inadequate loosening policies were criticized as too aggressive, he said nothing to defend them.
Now he's reportedly eager to name his former economic adviser Lawrence Summers to the Fed. Last year, Summers expressed the same complacent view — that because interest rates are low, the Fed can do no more to aid the recovery — that Obama did in 2009.
For Summers, the only effect of looser money would be to encourage a few marginal investments by lowering interest rates. It is, again, too narrow a view of what the Fed can do. The direct effects of a change in interest rates are less important than what the Fed signals about the future path of spending levels. If markets have confidence that the Fed is learning from its failures, both consumption and investment should start rising.
In a recent interview, Obama said one of the qualities he's seeking in a chairman is a willingness to stop "new bubbles" when "the markets start frothing up." It's true that the Fed can inflate bubbles by making money too easy and has done so in the past. But we're nowhere near that point now: Total household debt is still falling, which isn't a sign of bubbliness. If Obama wants a Fed that thinks otherwise, then his excessive worrying about bubbles is itself worrisome. It would be even more problematic if he wanted the Fed to play an active role in policing bubbles rather than just not causing them. That idea would take the Fed far beyond its legal mandate and its competence, and would instill a bias toward tightness.
My guess is that Obama doesn't know, think or care much about monetary policy. That's usually a good disposition for someone in the Oval Office to have. A president who was too interested in monetary policy would be tempted to interfere with the Fed. Indifference beats the attitude of many Republicans, who are still convinced, contrary to all the evidence, that rampant inflation is just around the corner.
While presidential apathy about central banking is usually a virtue, once every 70 years or so the economy suffers through a calamity of tight money. We found ourselves in that circumstance when Obama took office. The country could have been well served by a president who favored monetary looseness, a policy the Democratic Party has supported for about a century. Because of Obama's indifference, we had no such luck.
A lot of conservatives have adopted screwy ideas about monetary policy during the Obama years. They have been urging the Fed to tighten a policy that is already too tight. But the monetary mistakes of liberals have been the most consequential ones during these years. The likely nomination of Summers doesn't suggest that we'll see an improvement anytime soon.
Ramesh Ponnuru is a Bloomberg View columnist, a visiting fellow at the American Enterprise Institute and a senior editor at National Review.