Did Larry Summers Kick the Political Vending Machine?

I first met Larry Summers in a corridor at the University of Rochester. Famished and between sessions at a conference, Mr Summers had just deposited two quarters into a vending machine. His selected snack got stuck in the machine. Angered, he pounded the machine with his fists, and when that failed to dislodge the item, he seized the machine and began kicking it forcefully. Nothing, it seemed, would stand between Mr Summers and a Twinkie!

The US Democratic Party, however, has stood between Mr Summers and the post of Chairman of the Federal Reserve. Today’s news that Mr Summers has withdrawn his candidacy has fired up the markets. For some reason, Mr Summers is broadly perceived as a monetary hawk and some kind of free markets freak. This is astonishing since, far from being a right-wing free markets campaigner, Mr Summers is all about regulation, active monetary policy and market intervention.

For instance, Summers’ most widely cited publication is entitled “Noise Trader Risk in Financial Markets” (1990) Journal of Political Economy, which hypothesises that there is a class of ‘Noise Traders’ in financial markets who can systematically drive prices away from their fair equilibrium price. Noise traders are so powerful, according to Summers, that efficient arbitrage is unable to correct these pricing errors. The natural policy implication is that markets should be regulated and taxed in order to eradicate the Noise Trader (i.e. Wall Street).

The financial press is reporting that Summers nomination for Fed Chairman was opposed by the Democrats on the basis of him being a deregulator. This is clearly rubbish. My guess is that somewhere in the corridors of the Democratic Party he has more likely been caught kicking the proverbial political vending machine.

As for the market’s, the positive reaction to his withdrawal is not because he is a monetary hawk, rather it is because he ran the risk of regulating the markets out of existence.