What Rajan had that Summers didn't

The irrational hate that denied Larry Summers the Fed job is the flip side of the markets' adoration of Raghuram Rajan

Nobody can doubt that Raghuram Rajan, now governor of the Reserve Bank of India, is a very smart man indeed. But if there is one article of faith shared by most economists in North America, and by extension the world, it is that Lawrence J Summers, once US Treasury Secretary and more lately Barack Obama’s chief economic advisor, is the smartest man in the business. But, it seems, Summers is no longer the perceived frontrunner in the race to be Rajan’s American counterpart; he’s ruled himself out of the race.

This is likely to be greeted with as much jubilation as has been Rajan’s elevation, and with as little reason. The markets and investors have lavished affection on Rajan for reasons that are frankly non-economic – he’s a new, well-qualified individual who takes charge of a major institution at a time when economic leadership in India seems to be in short supply. There is little if no actual examination of the actions he’s likely to take, given his history – in fact, Rajan has throughout his career maintained that banks should care primarily about inflation, and use the interest rate to moderate it, so the rate cut that some in the markets seem to euphorically expect is, well, unlikely.

Summers has been excoriated for similar, non-economic reasons. He’s had a controversial career; more academic than politician, he has got into trouble more than once for thinking aloud, and posing questions that would be considered insensitive outside the seminar room. He’s brusque and abrasive where Rajan is affable and articulate.

Asking only one big question

There’s another major difference: Summers was on the wrong side of one big question, while Rajan was on the right side – and that’s on whether the increasing financialisation of the US economy that began in the late 1990s posed a systemic risk. Rajan, famously, warned a gathering of central bankers in 2005 at the height of the Alan Greenspan era that modern finance had made the economy more vulnerable. In response, Summers snapped the way he would have in a seminar room – Rajan’s views where “slightly Luddite”, he said. Summers had, of course, led the drive towards deregulation in the Clinton Treasury. But he was wrong and Rajan was right.

It seems nobody’s learned that judging people on their opinions about one big question isn’t always wise. Rajan may have been on the right side of the battle over finance, but that doesn’t mean he’ll be able to forget the habits of a lifetime and think outside the box about Indian interest rates. Nor does Summers’ past advocacy of deregulation mean that he’s unable to rethink his views in the face the pretty weighty evidence to the contrary provided by the 2008 crisis. One would think that those who supported Barack Obama purely because he opposed the Iraq War would have figured out that judging people by a single opinion is dangerous – Obama’s not exactly been an anti-war president. Quite the opposite, in fact.

A warning for Rajan

Summers resignation letter worries that his confirmation as Fed chair would be accompanied by so much acrimony that it would hurt the administration and the economy. This isn’t surprising: the kind of vicious and largely baseless attacks that have been thrown at him have few parallels for economists. He’s a soft target for those who think there’s “something wrong with economics”, but don’t know – for obvious reasons – what that may be. In India, perhaps only Montek Singh Ahluwalia has been the target of such invective; in the US, practically no economic policymaker ever has – particularly given the attacks on Summers came from both the right and the left.

Yet its hard not to see how “the smartest man in every room”, as Summers has often been described – and one more than capable of changing his mind, as testified to by most of his colleagues – was the right choice for the world’s most influential central bank. Instead, the world will have to settle for second best, purely because the media focused on very dicey questions of personality, ones hardly relevant to a technocrat’s job.

Rajan was on the right side of history once; and he’s a lot more marketable than is Summers. But, in the end, a central banker is judged by the calls he takes. Rajan may get as many wrong, perhaps more, than Summers would have. And then he should prepare for as few Facebook “likes” – to use his preferred metric – as Larry Summers has received.