Janet Yellen and Mario Draghi Have One Last Job
The U.S. treasury secretary and the Italian prime minister have spent decades shaping this economy. But can they control what comes next?
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In recent years, the world has been regaled with stories about the crisis of expertise. The era of the liberal technocrat was over, we were told, killed off by the financial crisis and populism. But if democracies find it hard to live with expertise, it seems they can’t live without it either.
In recent years, the world has been regaled with stories about the crisis of expertise. The era of the liberal technocrat was over, we were told, killed off by the financial crisis and populism. But if democracies find it hard to live with expertise, it seems they can’t live without it either.
At the start of 2021, two of the most contentious capitalist democracies in the world, Italy and the United States, turned to familiar experts to chart a way out of novel political situations. If there is such a thing as a technocrat, Janet Yellen, the new U.S. treasury secretary, and Mario Draghi, Italy’s new prime minister, are it.
For the last 30 years, both Yellen and Draghi have held positions of high authority, culminating in the period between 2014 and 2018 when they overlapped as the heads of the U.S. Federal Reserve and the European Central Bank (ECB), respectively, the two most powerful central banks in the world. They were chosen to wield power based on their expertise and judgment but also because they aligned with the prevailing brand of centrist politics—Yellen more on the left, Draghi more on the center-right. They have now been called back to the ramparts, at an age that would normally suggest retirement, to take on roles that are more political than ever.
Yellen, the first woman to lead the U.S. Treasury Department, is set to preside over the most audacious round of stimulus of any democracy in peacetime. Draghi, as prime minister, faces the challenge of returning Italy to growth with the help of an unprecedented allocation of 209 billion euros ($254 billion) from the European Union’s new Next Generation EU fund that was bargained at the outset of the pandemic.
Those are extreme tasks, demanded by the extreme situation the United States and Europe find themselves in. On both sides of the Atlantic, disappointed expectations and fears about the future are helping to stoke disruptive nationalist and right-wing politics. If broad-based growth cannot be restarted, the implications are alarming.
Of course, it would be absurd to blame either Draghi or Yellen personally for the sequence of shifts and shocks that has destabilized capitalist democracies since the 1990s or the crisis of confidence these have triggered among centrist liberals. But as people of huge influence and as representatives of a class of experts who have ruled the roost for the last 30 years, they can hardly plead innocence either. It was on their watch that growth slowed, inequality between social classes and regions became ever deeper, and the risk of inflation tipped into that of deflation. It was on their watch that the financial system was allowed to become a flywheel of mass destruction. It was on their watch that the risks of climate change and pandemic threats went unaddressed.
Whereas the market revolutionaries of the 1970s and ’80s were radicals, squashing the last bastions of the old left and bulldozing organized labor out of the way, Draghi and Yellen came to the fore in the 1990s as managers of what is now known as the Great Moderation. That is not to say they idolized the status quo. As Yellen once remarked: “Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not. Do policymakers have the knowledge and ability to improve macroeconomic outcomes rather than make matters worse? Yes.” But their idea of policy intervention took the existing institutional horizon as given. Not for nothing they came into their own as independent central bankers—the political position perhaps least accountable to democratic politics and the quintessential policy lever of the neoliberal era.
Inheritors of the market revolution, committed to managing and improving the status quo, Draghi’s and Yellen’s march through the institutions has been glorious, but their careers have also been defined by constant adjustment to political and economic shocks that they did not foresee and could not control. These shocks have driven Yellen and Draghi to explore the political and economic boundaries of technocratic power.
Draghi faced that challenge first. It was the power vested in him as boss of the ECB that enabled him to change the course of history with a single sentence. Draghi’s defiant exclamation in the summer of 2012 that he would do “whatever it takes” to save the eurozone was what philosophers of language call a performative utterance. Through his declaration, Draghi established the anchoring monetary authority that the eurozone had hitherto lacked.
For much of the period since the 1990s, American experts of Yellen’s ilk regarded the project of European monetary union with deep skepticism. Condescendingly, they benchmarked it against the U.S. experience and announced that Europe was still awaiting its Hamiltonian moment. But since 2008, at the latest, the tables have turned. Yellen and her colleagues in the United States have come face to face with structural problems of their own—in the U.S. financial system, the country’s profound social inequalities, its inadequate welfare state, and its deeply polarized politics. The tensions facing the Biden administration by the time it took office were so extreme that “whatever it takes” might as well be its motto, too.
Yellen and Draghi are no doubt qualified, but the question facing both in 2021 is blunt. Can they get a grip on the basic political and economic forces shaping their countries? The fact that they are in the positions that they are in, under the circumstances we currently face, is not a reward for lifetime achievement. It is a wager that they can deliver an escape from the terrifying mess that 2020 landed us in. Can they, in perhaps their last act, vindicate the past half-century of centrist expertise of which they are such prominent exponents? And will that require leaving most, if not all, of its basic organizing assumptions behind?
Yellen and Draghi are both prototypical success stories of the postwar period. They were born just over a year apart: Yellen in Brooklyn, New York, in August 1946, Draghi in Rome in September 1947. In the 1970s, they both earned Ph.D.s from powerhouse economics departments on the East Coast of the United States: Yellen from Yale University in 1971, Draghi from the Massachusetts Institute of Technology (MIT) in 1976.
Yellen and Draghi were both trained as Keynesians. Their careers and those of their collaborators are a standing refutation of the cliché that the last 50 years of economic policy—the period normally referred to as the neoliberal era—were defined by conservative Chicago-school monetarism or dogmatic rational-expectations economics. At MIT and Yale in the 1970s, they imbibed what was known as the neoclassical synthesis. The central idea was that though the microeconomics of markets were important, markets would function properly only so long as the macroeconomic environment was set correctly. Keynesianism and market economics were not opposites but complements.
In the 1980s, Yellen played an important part in shaping the further development of the neoclassical synthesis known as New Keynesian economics. Working alongside the likes of Joseph Stiglitz and George Akerlof, she mapped how labor market imperfections could give rise to macroeconomic problems. Those rigidities in wages and prices, in turn, also enabled macroeconomic policy to work. It was because markets were slow to adjust that unexpected movements in interest rates, taxes, and government spending could have real effects. Big, 1930s-style crises were not on the agenda. They were something that happened in the developing world. In the United States, secured by a solid and well-understood framework of macroeconomic policy, the challenging problems were of fine-tuning.
Draghi’s work at MIT was less intellectually generative than Yellen’s. But his dissertation is nevertheless revealing. It includes a chapter in which he describes how planners trying to manage an economy subject to short-run fluctuation are more successful if they focus on long-run goals. Long-range strategy, regardless of short-term cost, will do better than a hectic effort to optimize at every moment.
Though they owe little to the Chicago school, it does not follow that Draghi and Yellen were not exponents of neoliberalism. On the contrary: They were strong advocates of markets. Competition and properly designed incentives were the recipe for productivity and growth. In the world economy, they favored the free capital movement and flexible exchange rates that defined the so-called Washington Consensus of the 1990s. It was Rudiger Dornbusch, the pope of international macroeconomics at MIT and one of Draghi’s chief mentors, who described the project of his generation as being the taming of “democratic money.” In the wake of the collapse of the Bretton Woods financial order and the U.S. dollar’s gold peg, the chief enemies of good economic governance were shortsighted trade unions pushing for higher wages and vote-chasing politicians. Once trade unions were curbed and politicians confined to their proper tasks, Friedmanite monetarists hoped that prices could be stabilized by mechanical monetary rules.
But by the early 1980s, that had proved naive. For the MIT crowd, what keeping money safe from democracy amounted to was placing it under the control of competent experts credibly committed to providing markets with the stable framework they needed. The independent central bank was their institutional bastion.
By the early 1990s, Yellen was an influential figure in New Keynesian circles. It was no surprise when she was headhunted by Laura D’Andrea Tyson, the chair of President Bill Clinton’s Council of Economic Advisers, herself a MIT Ph.D. and Yellen’s colleague at the University of California, Berkeley. In 1994, Yellen was appointed along with Alan Blinder to the Federal Reserve Board. Their role was to counterbalance the Wall Street-centered approach of the Fed chair and Ayn Rand disciple, Alan Greenspan. It was a bruising experience.
In 1994, Greenspan was determined to crush any possible revival of inflation. He hiked interest rates, unleashing a violent bond market sell-off. The ensuing “bond market massacre” scarred the first term of the Clinton administration. This was the moment when Clinton’s political advisor James Carville declared that he wanted to be reincarnated as the bond market because you could intimidate anybody. In fact, the drama was not in the economy, where inflation was ebbing, or inside the Clinton administration, which was falling over itself to prove its fiscal conservatism. It was inside the Fed. It was Greenspan who was acting the maestro.
Unable to exercise any influence, Blinder left abruptly in 1996. Yellen departed in 1997 to take over as chair of Clinton’s Council of Economic Advisers. With the gloss on Ronald Reagan’s morning in America looking worn, Robert Rubin and Larry Summers sought to offer a new economic model—one that combined fiscal discipline with growth and full employment. Yellen was a true believer in this “new economy,” insisting that private investment would drive a surge in productivity growth. To encourage competition, Clinton’s economic team pushed the North American Free Trade Agreement. They also smoothed the path for financial modernization, which meant repealing New Deal-era regulations like the Glass-Steagall Act and letting Wall Street off the leash. Environmental policy was also part of the mix. In 1998, Yellen played an inglorious part in the effort to get the Kyoto Protocol past a furious Congress. It was her calculations that showed that the United States could keep its costs down by buying in carbon credits from the bankrupt countries of the former Soviet bloc.
The reform program of the 1990s was a long-run project.
The key question was whether Clinton’s new version of the Democratic Party could consolidate a majority. The party was increasingly dominated by the educated class, and sociodemographic trends in U.S. society seemed to be trending their way. Clinton won in 1992 and again in 1996. But Congress was another matter. The 1994 midterms were a disaster that handed power to the insurgent right wing of the Republican Party led by Newt Gingrich. For all their sense of having history on their side, what the modernizing technocrats of the Democratic Party faced, in fact, was a resurgence in conservatism. It turned out that America’s rapid social, cultural, and economic transformation was splitting the country in half.
Gingrich liked to talk of revolutions. It was always a pose. What he was waging was more like trench warfare. The Italian political scene of the 1990s, in which Draghi rose to prominence, was closer to an actual revolution.
Italy, too, was divided over the legacies of the 1960s and ’70s, but there the end of the Cold War and the Tangentopoli corruption scandal of 1992 swept away the existing three-party system, in which Christian Democrats competed with communists and socialists. The collapse of the Christian Democrats spawned the rise of a new right wing, headed by Silvio Berlusconi and the Northern League. Meanwhile, for those Italians who since the 1970s had gravitated toward a historic compromise between Eurocommunism and the left wing of Christian democracy, the EU was the answer. Italy would be modernized by the discipline of vincolo esterno, or external constraint. Enlightened rules set in Brussels and a unified European single market, ultimately completed by a currency union, would set a high bar for competition and root out corruption and inefficiency.
Reform-minded Italians discuss in heated terms their attachment to such external props. It goes back to British and French sponsorship of Italian unification in the 1850s. But the search for constraints wasn’t merely an Italian curiosity. The global financial order developed by economic elites—from the 19th-century gold standard to the gold-pegged dollar of the Bretton Woods system to the worldwide preoccupation with independent central banks after Bretton Woods dissolved—has always involved imposing constraints on policymakers. In the 1980s, devices such as exchange rate pegs were all the rage in Asia as well as Europe for signaling self-discipline to financial markets.
The advice from economists, however, was equivocal. Tying yourself to a conservative anti-inflation anchor like Germany’s Bundesbank had obvious attractions, but as much as mainstream macroeconomics campaigned for price stability, both the Chicago and MIT schools favored floating exchange rates. All that was really needed for price stability was responsible national monetary policy.
From the vantage point of the United States, that made sense, but it took the existing order of nation-states for granted, which was precisely what European integration put in play. Support for monetary union implied a gamble on eventual convergence and the creation of a more elaborate structure of common fiscal policy. Ultimately, it assumed the emergence of a European polity and society that would facilitate joint decision-making and labor mobility. It was a project not of stabilizing the status quo but of historic transformation.
As far as Italy was concerned, after the signing of the Maastricht Treaty in 1992, it looked like a very long shot. The country’s politics were in turmoil. In an unprecedented attack, the Mafia assassinated the top magistrate Giovanni Falcone. Public finances were in chaos. In September 1992, Italy and the United Kingdom both crashed out of the European Exchange Rate Mechanism, the halfway house to monetary union. Draghi was in the middle of the fight.
Back home in the late 1970s, watching his family inheritance being eaten up by rampant inflation, Draghi had bounced around Italy’s highly politicized university system until 1984, when he became an executive director at the World Bank in Washington. He was not lured back to Rome until 1991, when he was asked to take the job as director-general of the Italian Treasury. He was appointed by then-Prime Minister Giulio Andreotti, the spider in the web of Christian Democratic politics, but Draghi’s loyalties were with the vincolo esterno camp. Faced with the 1992 crisis, the choice was clear. Unlike the U.K., Italy would do whatever necessary to rejoin the convoy toward monetary union. To redress the national budget deficit, Draghi curbed expenditures. To bring down the debt, he drove large-scale privatization of Italy’s huge state-owned enterprises. Always a man of the markets, Draghi also pushed the Italian Treasury to adopt techniques of financial engineering to juggle its debt mountain.
It came at a considerable cost. Growth slowed to a crawl. Many of Draghi’s former teachers at MIT, led by Franco Modigliani, his Ph.D. supervisor, went public with their doubts about the stringent Maastricht criteria for euro membership. But the Europeans persisted, and as far as Italy was concerned, in the early 2000s, the plan seemed to be working. Though fiscal austerity slowed Italy’s growth and hindered productivity gains, the straitjacket held. Though Berlusconi took office for the second time as prime minister in 2001, his room for maneuver was constrained. Meanwhile, Italians were not merely subject to European constraint; they achieved considerable prominence in Brussels. Romano Prodi, as European Commission president between 1999 and 2004, oversaw the introduction of the euro. Mario Monti shaped EU taxation and competition policy. At the ECB, Tommaso Padoa-Schioppa was widely seen as the intellectual father of the euro. Vincolo esterno was not merely a surrender; it was a way for Italy to secure leverage on the larger European stage.
Draghi, meanwhile, after a few years at Goldman Sachs, was called back by Berlusconi in January 2006 to head the Banca d’Italia, Italy’s central bank. Though the bank was in turmoil thanks to allegations of impropriety against his predecessor, Draghi inherited a complacent scene. Markets were calm. For Italy, as for Greece, borrowing costs were at historic lows. The symbiotic relationship between public finances, markets, and investment banks that Draghi had helped forge seemed to be working well.
By contrast, what made itself painfully evident in the United States in the early 2000s was precisely the lack of any external restraint on policymaking. Driven by the radicalization of the nationalist right wing, U.S. politics became not just polarized internally but divorced from the norms prevailing in Europe. It is rightly said that Berlusconi was the godfather of the modern oligarchic populist style. But though it toyed with climate skepticism, Italy never broke from the European mainstream. It wasn’t in Italy that fundamentalist religion was welcomed in the halls of power. In the United States, by contrast, even elementary democratic norms no longer seemed safe.
In 2000, though Al Gore had won the largest number of popular votes, Supreme Court judges nominated by George W. Bush’s father handed him the election victory. Unconstrained by any domestic check, the budget was blown out by ruthless, inegalitarian tax cutting and Bush’s wars of choice. Figures like Paul Krugman, a contemporary of Draghi’s at MIT, were driven into radical opposition.
Yellen was more restrained. Rather than taking to the streets, she took charge as president of the Federal Reserve Bank of San Francisco in June 2004. She was chosen in part because she had forged a reputation, in the words of Berkeley’s chancellor at the time, as an “outspoken advocate for fiscal responsibility.” In 2004, that was a liberal stick to beat the Republicans with.
While Yellen immersed herself in the day-to-day of policymaking, other true-believing disciples of the Clinton-era “new economy” looked around for their vincolo esterno. They remembered only too well the pressure they had been under by bond markets in 1994. Surely, the Bush administration’s recklessness with deficits would soon face its comeuppance. The most likely scenario seemed to be that it would come in the form of a wallop from China, the largest holder of U.S. debt. Beijing would sell. The dollar would crash. Interest rates would surge. That would teach Republicans that no one was above the economic rules. But the external check, America’s vincolo esterno, never arrived. The dollar remained king. The shock came from within.
In 2008, a financial crisis did sweep Republicans out of office. But it was not the crisis that Democratic technocrats had anticipated. It wasn’t the government bond market that blew up. It was mortgage-backed securities and banks.
The embarrassment was that whereas on fiscal policy and the trade deficit one could point the finger at irresponsible Republicans, on the financial sector there was really no room between the parties in the United States—or for that matter between the Americans and the Europeans. In the Clinton administration, the charge on financial sector deregulation was led by Summers at the Treasury Department, but as chair of the Council of Economic Advisers, Yellen had raised no objections. Nor had there been any resistance from the other side of the Atlantic.
At least Yellen had not made Draghi’s faux pas of working for Goldman Sachs or signing up for a hedge fund like Summers or running Citigroup like Rubin. From her vantage point at the San Francisco Fed, she did take note early of the signs of a housing crisis; in California, you could hardly miss them. But as late as July 2007, Yellen opined: “From the standpoint of monetary policy, I do not consider it very likely that developments relating to subprime mortgages will have a big effect on overall U.S. economic performance, although they do add to downside risk.” A few months later, Draghi, as head of Italy’s central bank and chair of the international Financial Stability Board, would give a speech on the transformation of the European financial industry in Frankfurt that acknowledged the crisis going on in securitized mortgage business but insisted that it was up to the private sector to sort it out. He failed to highlight the systemic risks in the investment banking operations of Europe’s megabanks or the doom loop connecting European banks and sovereign debt.
For all their inside status and expertise, neither Yellen nor Draghi gave any public sign of anticipating the crisis that was to come. The same was true for the vast majority of their cohort, whether MIT or Chicago. The scale of the systemic risk posed by the financial system of the advanced economies simply did not register until it was too late.
Once the crisis arrived, the appropriate economic policy was obvious, at least in outline. The United States needed fiscal stimulus—the only question was how big. The shadows of the 1990s lingered over President Barack Obama’s economic policy team, which was recruited, in the main, from the circle around Rubin. Concerns about debt sustainability never lifted. As critics like Krugman soon began to warn, the Obama stimulus of 2009 was nowhere near large enough—about half the size that would have been necessary to fill the output gap. Christina Romer, Yellen’s close colleague at Berkeley and another MIT Ph.D. who was serving as Obama’s chair of the Council of Economic Advisers, correctly gauged the challenge, but she was overridden. The public protests in the media from conservative economists didn’t help. But it was Summers, once the golden boy of MIT and Yellen’s onetime student, who clinched the argument from the inside, in his position as director of the National Economic Council. A stimulus in excess of $1 trillion was, in his words, “non-planetary.” Meanwhile, the Republican opposition in Congress, the heirs to Gingrich, hemmed the Obama administration in until, during the 2010 midterms, they were able to retake power. As Democrats assembled their multiracial, expert-led coalition for a new America, the temperature on the right—from Gingrich to Sarah Palin to the Tea Party—kept rising.
For lack of fiscal stimulus, the Fed was left to pick up the pieces. Ben Bernanke, a Republican appointee from the same MIT cohort as Draghi, worked well with the Obama administration. To reinforce his dovish tendencies, in April 2010 Obama nominated Yellen to the Fed board, this time in the hot seat as vice chair. Faced once again with Republican control of Congress and fiscal paralysis, Yellen became one of the loudest voices pushing for more monetary policy stimulus to sustain the recovery.
Fortunately for Italy, it was not on the front line in 2008. Its long-run growth path since adopting the euro may not have been promising, but its banks were not entangled in the mortgage boom. What the Italian Treasury could ill-afford, however, was a general panic in eurozone sovereign debt markets—and that’s precisely what started in 2010 in Greece, Ireland, and Portugal. By 2011, Draghi found himself in the heart of the desperate effort to stave off disaster in the eurozone. This required dealing with the Berlusconi problem by more direct means than vincolo esterno. What was needed was inside pressure. In August 2011, Draghi and ECB President Jean-Claude Trichet teamed up to write a secret missive to the prime minister demanding he make drastic cuts, sanctioned if necessary by the application of emergency laws. When Berlusconi demurred and lost his grip on Parliament, an alternative candidate was ready and waiting. Draghi himself had been discussed on several occasions as a possible prime minister, but he was now on his way to the ECB to succeed Trichet. The fix for the Italian premiership was Mario Monti, the economist and former EU commissioner who in the 1970s had studied at Yale with James Tobin, Yellen’s Ph.D. supervisor.
It was not the only technocratic substitution with an American flavor performed in Europe in the fall of 2011. At the same time, in November, Greece and its latest austerity program were put in the hands of Lucas Papademos, who held a bachelor’s degree in physics, a master’s degree in electrical engineering, and a doctorate in economics, all from MIT.
Working closely with Spain, Monti anchored a push for fundamental moves on banking union that over the summer of 2012 opened the door to Draghi’s famous “whatever it takes” line. The financial markets were calmed. But the price was paid in the destabilization of European democracy.
Initially, the public reaction to Berlusconi’s replacement by Monti was overwhelmingly favorable. The crisis, the Italian public conceded, required a democratic exception. But the honeymoon did not last. Feeding off the indignation provoked by Monti’s hard line on fiscal policy and apparent indifference to the social crisis afflicting Italy, in the February 2013 parliamentary election, the Five Star Movement, avowedly skeptical of the EU, surged to 25 percent of the vote. And the populist backlash was now spreading across Europe. The Alternative for Germany party emerged on the scene in 2013 as a challenge to Draghi’s rule at the ECB. The National Front in France gained enormously in popularity. Podemos in Spain and Syriza in Greece both openly espoused leftist populism. Draghi became an object of hate, but the real target was vincolo esterno, the abstract mechanism of constraint that now stifled all initiative.
For all of Draghi’s fine words, the ECB did not actually act in 2012. The eurozone slid deeper into recession. It was the Fed that did act. In September 2012, the Fed announced QE3, an open-ended bond-buying program to keep interest rates at rock bottom. With fiscal policy paralyzed by the standoff between the Republican-led Congress and the Obama administration, Bernanke, with Yellen’s support, committed to keeping his foot on the gas until unemployment fell below 6 percent.
By this point, the left wing of the Democratic Party was getting restless. When the question came of Bernanke’s replacement, the idea that Summers was the anointed heir stirred indignation. Despite her own Clintonian past and despite the fact that she was a card-carrying member of the Fix the Debt campaign, Yellen emerged in February 2014 as the compromise candidate backed by the likes of Sens. Elizabeth Warren and Sherrod Brown.
She had reached the pinnacle of economic policymaking on the basis of her track record both as an academic and a policymaker but also because of her astute political positioning. In an increasingly polarized political environment, there was no such thing as neutral expertise. And, at least at first, Yellen showed every sign of repaying the trust of the left by maintaining quantitative easing (QE) until October 2014, when unemployment was around 5 percent.
Though the recovery in the United States was painfully slow, the situation in Europe was far worse. Draghi’s “whatever it takes” approach had stopped the acute bond market crisis, but by 2014 the eurozone was teetering on edge of deflation and renewed recession. Draghi, who had previously been a staunch advocate of fiscal consolidation, was now pleading for an active fiscal policy. “Whatever it takes” from the central bank could only go so far. What was required was a proper balance of monetary and fiscal policy. But in Berlin there were no MIT Ph.D.s. With then-German Finance Minister Wolfgang Schäuble doggedly pursuing budgetary surplus, rather than fiscal stimulus, vincolo esterno was now garroting the eurozone.
The consistent failure to deliver adequate fiscal policy responses to the crisis after 2008 went against all the preconceptions of 1970s MIT-style macroeconomics. Where were the spendthrift politicians when you needed them? The fiscal undershoot by the Obama administration could perhaps be explained by miscalculation and Republican partisanship. But the fact that a centrist majority in the heart of Europe, faced with dangerous populist challenges from the left and right, would choose to die on the hill of budget balance was not part of the plan.
It was up to the ECB to act. In 2015, to the horror of German conservatives, Draghi finally launched a QE program. This was a technical economic measure. But it had spectacular political effects. It enabled the European Council to play hardball with the radical left-wing government in Greece without causing the bond markets to panic. It insulated Europe from the shock to confidence during the refugee crisis and to some degree against the sudden downturn in China. One might say it marked the Americanization of the ECB. But precisely at that moment, a fateful division was emerging between Europe and the United States. Draghi was pumping liquidity into the European financial system just as Yellen began to contemplate the possibility of actually raising rates.
Seven years on from the collapse of Lehman Brothers, a majority on the Fed board was swinging toward tightening. The point was not so much that the U.S. economy needed restraining as that they were deeply uncomfortable with interest rates remaining at zero. It stoked speculation in financial markets and gave the Fed nowhere to go if it needed to counter a downturn. Negative interest rates along the lines adopted by Japan were not something that the Fed wanted to contemplate. There was just one problem: the sudden deterioration of the world economy. In 2015, commodity prices were plunging. China was looking shaky. Financial markets were wobbling.
Nevertheless, on Dec. 16, 2015, Yellen announced the decision to raise rates. “I feel confident about the fundamentals driving the U.S. economy, the health of U.S. households, and domestic spending,” she declared. “There are pressures on some sectors of the economy, particularly manufacturing and the energy sector … but the underlying health of the U.S. economy I consider to be quite sound.” At that point, on the basis of the broad measure of unemployment known as U-6, 16 million Americans, or 9.9 percent of the workforce, were still unemployed or underemployed. After years of undershooting, core inflation was at 2 percent, but excluding housing, which was recovering from the real estate crisis, it was closer to 1 percent.
With the ECB pushing in the opposite direction, the torque applied to the U.S. economy was painful. Over the first three years of Yellen’s term at the Fed, the dollar appreciated by more than 26 percent in trade-weighted terms. Manufacturing was hit hard. Large parts of the United States entered the 2016 election year in a mini-recession. In many blue-collar constituencies, plants were closing, and the outlook was dire. Sen. Bernie Sanders did not hesitate to attack Yellen in December 2015 for what he regarded as a grossly premature tightening. In 2016, Donald Trump was poisonous, accusing the Fed of being in cahoots with Democrats. Days before the election, he rounded out his campaign with what was perhaps the most outrageously anti-Semitic attack in recent U.S. electoral history, pillorying Yellen alongside George Soros and Lloyd Blankfein of Goldman Sachs.
Yellen was chosen as Fed chair as a candidate of the liberal left. The triumph of Trump and America’s radical right sealed her fate.
At first, it seemed that Europe might have dodged the populist bullet. In 2017, Macron defeated Marine Le Pen and her National Front. But in Italy, the pressure was mounting. And in 2018, the vincolo esterno strategy finally blew up. In the March 2018 election, the Euroskeptic Lega and the Five Star Movement split almost 70 percent of the vote between them. An intervention by Italy’s grizzled president, Sergio Mattarella, was necessary to ensure that an openly anti-euro professor did not take charge of Italy’s finance ministry. Europe was not an external constrainer, he emphasized, but the guarantee of Italy’s future. The bond market reacted with alarm. There was talk, as in 2011, of an Italian debt death spiral.
So long as the ECB stood ready to prop up the market, Italy could limp on, but what QE did not do was revive rapid economic growth in the European economy. In 2019, Europe was once again at risk of sliding into deflation. Far from catching up, Italy was further behind than ever. Its per capita GDP in 2019 was about 3 percentage points lower than in 2000—two lost decades of growth. As Draghi pleaded for fiscal action, Berlin dug in its heels. In September 2019, in desperation, Draghi resorted to another round of QE. Once again, he earned a storm of opprobrium from Germany. It was all that Berlin could do to give him a dignified send-off from Frankfurt.
The basic framework of 1970s macroeconomics that framed Draghi and Yellen’s training and outlook, like that of the rest of their cohort, was that properly structured markets would take care of growth. Well-regulated financial systems were stable. The chief priority for economists was to educate and restrain politicians to ensure that inflation remained in check and public debts were sustainable.
In the United States, this was institutionalized in the form of an elite bargain with Republicans—or at least so the economists imagined—to jointly manage the budget, the key regulatory agencies, and the Fed. In Europe, that structure was in the process of creation. A review of Yellen’s and Draghi’s careers, for all their personal accomplishments, is the story of the shipwreck of those expectations.
Financial instability is a mortal risk. For now, it is being held at bay. But the world saw as recently as March 2020 how rapidly even the largest financial market—the market for U.S. Treasurys—can be destabilized. To tame that risk, the Fed and the ECB, under Yellen’s and Draghi’s non-economist successors—Jerome Powell and Christine Lagarde, respectively—have adopted an astonishingly undogmatic and expansive approach to stabilization.
Inflation, once considered the most serious threat, is not a realistic prospect and is one that, if it were to reemerge, can clearly be handled by the central banks. The priority instead is to restart growth and thus secure the foundation for stable democratic rule both in the United States and the weaker parts of the eurozone, of which Italy is by far the most important.
As far as Italy is concerned, the 2020 crisis has miraculously delivered the most expansive vision of accommodating political circumstances that any advocate of vincolo esterno could have imagined: a lifting of fiscal rules, a bond market stabilized by the ECB, an injection of capital investment and funding from the EU equivalent to 10 percent of Italy’s GDP, a political mood in Germany broadly congenial to action, and a president in France who is desperate to save himself. The question now is whether Italy can recharge its growth engine. Or is it too late? Is the damage done by two decades of stagnation too deep? Are the global conditions for an export-orientated economy like Italy’s simply too tough?
On the one hand, it is fitting that the task of implementing the EU’s new common fund, Next Generation EU, should fall to one of the original architects of the vincolo esterno strategy of 1992. On the other hand, the fact that it does is also testament to the failure of that project. Draghi’s personal qualities aside, the Italian political class is abdicating in favor of a retired, unelected official in his 70s. The fact that Draghi is in power is owed to the machinations of Matteo Renzi, once seen as a young champion of the center-left, now reduced to the role of a disruptive spoiler. Matteo Salvini of the League is biding his time. The one option that Rome was not willing to consider when Conte’s government fell in January was an election. The current Parliament is too afraid of the far-right Brothers of Italy party, which makes Berlusconi and Salvini seem tame.
Cleverly, Draghi has refused to make the mistake that dogged Monti’s premiership. He has appointed a cabinet not of nonpolitical technicians but of representatives of the parties. They will not be allowed to excuse themselves of responsibility or snipe from the sidelines. But Draghi remains at the center. He is no caretaker like Conte, who startled Italy by developing into an effective leader. The expectations of Draghi are of a different order; he is “Super Mario.” There is no escaping the fact that faced with a decisive historical challenge—restarting growth after decades of stagnation—Italy’s political class has chosen to delegate executive power to someone who has never been elected to office. It is the ultimate victory of technocracy but also a do-or-die challenge. Given the self-abasement of the political class, if the combination of Draghi and Next Generation EU fails to deliver growth, what future prospects are there at all?
No one could accuse the Biden administration of being nonpolitical. The central organizing idea for both the White House and congressional Democrats is not to get caught in the logic of the Clinton and Obama administrations. The irresponsible thing to do at this juncture would be to be “responsible” on fiscal policy. Despite her track record, precisely on the issue of fiscal responsibility, Yellen was once again the candidate for treasury secretary acceptable to the left wing of the party. It helps that in 2016, even as the Fed continued to raise rates, Yellen began to advocate for a “high-pressure economy” that would deliver full employment and uplift even those at the bottom end of the U.S. labor market. The idea was a blast from the past. It was coined by Arthur Okun, a leading Yale economist in Yellen’s time there in the early 1970s who, like Tobin, Yellen’s doctoral supervisor, had done a stint on the Council of Economic Advisers in the ’60s.
What is at stake in the giant stimulus program launched by the Biden administration is not just the social crisis left by the wreck of the U.S. labor market. In light of developments in the Republican Party, securing a liberal vision of U.S. democracy demands of the Biden administration that it not lose control of Congress. Whereas Draghi is facing the final battle for the technocratic vincolo esterno strategy, Yellen has cast her lot with the cause of politics.
The economics team in the Treasury and the White House continues to offer technical justifications. They insist that their calculations show that fear of overheating is overdone. But the stimulus push is above all the result of political calculation. The ultra-fine balance in Congress means that the left as well as the center of the Democratic Party have real sway. They demand that a Democratic administration should actually deliver for the people who elected it. Any attempt at finding common ground with Republicans has been abandoned. The result is what has been called the most audacious break in U.S. policy consensus since the 1980s. It means accepting, as Krugman put it in his most recent collection of essays, that in 21st-century America, everything is political. Republicans have taken that stance since the 1990s. Now finally Democrats are catching up.
Biden’s stimulus package, the American Rescue Plan, was pushed over protests from none other than Summers. The left cheered. But Summers made at least one crucial point. The plan may be a crisis response. It will no doubt give the U.S. economy a high. The question is, will it last? Certainly what no one could claim for the plan is that it offers a long-run vision. And if the truly strategic challenge facing progressive politics in the United States as in Europe is to find a new model of inclusive and environmentally sustainable economic growth, then the Biden administration has yet to deliver. Everything, in fact, hinges on a promised infrastructure program to come. That will be the real counterpart to the Next Generation EU program.
In the 1990s, you didn’t need to be a naive exponent of the post-Cold War end-of-history argument to think that the direction of travel for global politics was clear. The future belonged to globalization and more-or-less regulated markets. The pace was set by the United States. That enabled technocratic governments to be organized around a division between immediate action and long-term payoff. That was the trade-off that Draghi evaluated in his MIT Ph.D. in the 1970s. The drama of Draghi and Yellen’s final act is that for both of them, and not just for personal reasons, the trade-off is no longer so clear-cut. If the short-term politics fail, the long-term game may not be winnable at all. “Whatever it takes” has never meant more than it does today.
Adam Tooze is a history professor and director of the European Institute at Columbia University. His latest book is Crashed: How a Decade of Financial Crises Changed the World, and he is currently working on a history of the climate crisis. Twitter: @adam_tooze