Janet Yellen’s Nomination: A New Hand on the Tiller
The Federal Reserve: A new hand on the tiller
Oct 9th 2013, 18:29 by The Economist
[Greg Ip] JANET YELLEN’S nomination to chair the Federal Reserve is ground breaking, and not just because she will be the first woman in the job. She would also be the first known dove to hold the position.
Monetary doves worry more than their peers about unemployment, and worry less than hawks about inflation. Presidents once felt compelled to appoint hawks such as Paul Volcker and Alan Greenspan, or at least people not thought to be doves, such as Ben Bernanke, to reassure markets that the Fed would not succumb to the political system’s inflationary bias. Ms Yellen was, by most accounts, not Barack Obama’s first choice to succeed Ben Bernanke. But in appointing her he has implicitly acknowledged how much the world, and the Fed’s priorities, have changed. Since 2008 America and much of the world have struggled with slack demand and high unemployment while inflation, excluding energy, has persistently fallen short of the Fed’s 2% target.
Ms Yellen is not alone in believing that unemployment is a bigger problem than inflation now. So did Larry Summers, the front runner for the job until Democratic opposition forced him to withdraw last month. Most of her colleagues on the Fed’s policymaking Federal Open Market Committee agree. But she has felt that way longer, and more strongly. She pushed, publicly, in 2012 to hold interest rates near zero for longer than the Fed then expected, to hasten the fall in unemployment, even if it meant inflation briefly rising above 2%. She was the principle architect of the Fed’s current statement of long-term goals and operating principles which notes the equivalent importance of the Fed’s goals of full employment and low inflation and the circumstances under which it might put more weight on one versus the other.
Her preoccupation with employment goes back a long time. Her thesis adviser at Yale was James Tobin, a liberal lion and future Nobel prize winner. Her initial research was in international development but she made her mark studying labour markets. The theory of the “efficiency wage,” developed with her husband and future Nobel laureate George Akerlof, posited that workers who felt poorly paid were less productive. Knowing this, employers would pay them more than the market-clearing wage, which would raise unemployment. Ms Yellen and Mr Akerlof also demonstrated how firms and individuals might rationally decline to adjust wages or prices in response to a monetary shock. That collective behavior would produce recessions. By setting Keynesian macroeconomic theory upon microeconomic foundations, this work helped build the “New Keynesian” paradigm which is how most central banks still view the world.
In 1996, during her first stint on the Federal Reserve Board, she also took on the Fed’s hawks by advocating a target of 2% inflation rather than zero. Low positive inflation made it easier to achieve real wage adjustment, and for the Fed to engineer negative real interest rates (ironically, Mr Summers made the case first, in 1991.) That view has weathered events well.
Ms Yellen’s longtime advocacy of a 2% target virtually guarantees that she would tighten rather than let inflation become embedded above that level. “There are no doves on the [FOMC] when it comes to defending” the 2% target, says Larry Meyer of Macroeconomic Advisers who served with Ms Yellen on the Fed in the 1990s. Roberto Perli, a former Fed staffer now with Cornerstone Macro, says, “[Ms] Yellen herself would most likely welcome a reemergence of domestic inflation and, consequently, the opportunity to tighten policy as it would mean that the economy would be finally firing on all cylinders again.”
But inflation is no longer what separates hawks from doves. Hawks these days complain that the Fed’s expansive monetary policy distort financial prices, breed risk-taking, and strips the discipline from fiscal authorities. Fed officials share some of those concerns but Ms Yellen less than most. As vice-chairman, she helped Mr Bernanke nudge the FOMC towards its current, expansive stance, marked by a commitment to keep the federal funds rate at zero (where it has been since late 2008) at least until unemployment has dropped to 6.5% or lower, and to keep buying $85 billion per month of bonds with newly printed money (“quantitative easing,” or QE) until the labour market has improved substantially.
As chairman, though, Ms Yellen’s dovishness could also pose liabilities. She takes the job at a time when monetary policy has become almost as divisive as fiscal policy. Republicans in the Senate (which must confirm her) don’t like QE or her support for it. Four of the Republicans on the Senate Banking Committee today were there when she was nominated to be vice chairman in 2010. All four voted against her confirmation then. “She was not particularly modest about the role of monetary policy in the economy and I don’t see any evidence that’s changed,” one of those Republicans, Bob Corker of Tennessee, said on CNBC today. With the support of all 54 Democrats and Democrat-aligned independents, Ms Yellen is almost certain to be confirmed. Republicans have little motive to filibuster her. She may be the most qualified candidate for the job in history, and Mr Obama is not about to nominate a hawk. But with many Republicans opposed, she will probably get less than the 70 votes Mr Bernanke did for his second term—at the time was the lowest on record for a Fed chairman.
While Republicans won’t keep her from being confirmed, they can influence her policies in other ways. One of the seven seats on the Fed’s board is vacant and another five could become vacant in the coming year, given expirations and the tug of other opportunities. To placate Republican opposition, Mr Obama may feel compelled to nominate candidates whose views are not too close to Ms Yellen’s.
This highlights Ms Yellen’s other challenge: forging consensus on a committee where many members don’t share her dovishness. People who have worked with Ms Yellen describe her as persuasive and meticulously well-prepared, though scripted. She is more of a consensus builder than Mr Summers would have been, but less so than Mr Bernanke. And even Mr Bernanke has struggled to forge consensus at a time when the Fed’s policies are so untested and the circumstances so difficult.
Earlier this year, Mr Bernanke hinted that QE would start to taper this year, and end by next year. But in September the Fed wrong-footed markets by sticking with its current $85 billion per month pace, and it now seems likely that the present pace will continue at least through December. The confusion, according to a recent report in the Wall Street Journal, is due to competing tensions between a group of hawks which includes several governors (and not just usual suspects from the 12 reserve banks, five of whom vote at any given meeting), and Mr Bernanke’s lingering concerns that the economy had yet to reach take off speed.
Ms Yellen has been publicly silent on monetary policy for months but likely sided strongly with Mr Bernanke on the decision to forego a taper for now. Once in office, she will probably pursue the same path he would have—a gentle taper coupled with a firm commitment to keep the funds rate at zero. Where Ms Yellen may differ is “if the economy fails to strengthen as anticipated and inflation stays very low”, says Krishna Guha, a former official at the New York Fed and now an analyst at ISI Group. Ms Yellen “would fight to keep buying assets at $85 billion a month for as long as she could deliver the committee…But even with Yellen there are not the votes for QE Infinity, and cost-benefit analysis would eventually rear its head again.”
The original post is linked here.