On October 9, 2013, President Obama nominated Janet Yellen to be the next chair of the Federal Reserve Board. In the likely scenario she is confirmed by the Senate, Yellen will be the first female Fed Chair and first Democratic Fed Chair since 1987. Yellen has served as vice chair under Chairman Ben Bernanke since 2010. She has also served as president of the Federal Reserve Bank of San Francisco and chair of the White House Council of Economic Advisers under President Clinton.
Yellen faces a long list of policy challenges as the Fed nears the tapering of its quantitative easing program and seeks to balance its dual mandate of bolstering employment and keeping inflation in check. Given her past emphasis on employment, along with a degree of bipartisan support, Yellen is well positioned to provide sound monetary policy for the recovering yet still vulnerable American economy.
Technocratic Leadership Versus Party Politics
Even though Yellen will be the first Democrat to chair the Fed since 1987, recent history suggests that the party affiliation of the chair matters little. One might expect Republicans to run a tight monetary policy and Democrats an easy one, given prevailing party positions. But consider that Democrat Paul Volcker, who was appointed by President Carter, ran a Fed dedicated to fighting the high inflation of the late 1970s, leading President Reagan to reappoint him. On the other hand Ben Bernanke, a Bush appointee, pursued an expansionary monetary policy that led Obama to reappoint him.
Indeed, the Fed chair is a largely de-politicized position. Benjamin Friedman, professor of political economy at Harvard, told the HPR that “especially with recent appointments, the Fed has become highly professionalized as opposed to politicized, and neither Ben Bernanke nor Janet Yellen is visibly or actively identified by political party.”
However, the parties still have conflicting views on monetary policy and can exert pressure on the Fed. For example, Harvard’s Niall Ferguson explained, “the reality is that Fed policy is now so dominant in macro terms that if Janet Yellen’s optimal control theory implies rate hikes in 2016,” which would slow economic growth to prevent inflation, “somebody’s going to give her a phone call, because that’s the election year.” Political pressures, it seems, are alive and well.
Democrats have largely been uniform in their support of the Fed as an institution. Republicans, on the other hand, have serious reservations regarding the Fed’s role in the economy. James Pethokoukis, a columnist at the American Enterprise Institute, told the HPR, “there are very few people on the right who at this point think that the Fed’s policies are correct. The vast majority of Republicans think the Fed is making a huge mistake right now and that it’s risking higher inflation.”
For example, Senator Richard Shelby (R-Ala.), then the top Republican on
the Senate Banking Committee, voted against Yellen’s confirmation to be vice chair of the Fed in 2010, saying Yellen had a “Keynesian bias toward inflation.” More explicitly, Tea Party leaders and libertarians have called for measures such as auditing or even disbanding the Fed. These critics contend that the Fed’s expansionary monetary policies, including quantitative easing, have been grossly nontransparent and would lead to rampant inflation and more bubbles.
Ferguson describes these critics as “distinctly cranky thinkers, gold standard nuts, and people who don’t really understand what causes inflation” but he still believes that “there is a pragmatic core in the Republican Party that knows that monetary policy is the only game in town and that if you tighten prematurely you do a Europe to yourself.” Although those such as Pethokoukis and Ferguson disagree on the overall Republican sentiment towards monetary policy at this time, Yellen will likely receive at least some GOP support for her confirmation.
The Policy Divide and Yellen’s Significance
Curbing unemployment versus taming inflation is a divide that has largely set
up the two camps of the monetary policy debate today: hawks and doves. Hawks are concerned about inflation rising too high and worry about expansionary monetary policies leading to new bubbles in housing and other sectors. Doves believe that policies including a near-zero federal funds rate, the main short-term interest rate the Fed targets, and quantitative easing to lower long-term rates are needed at this time to reduce unemployment.
Yellen has been perceived as a dove. Her academic work and tenure in the
Fed have contributed to the view that she is more concerned with unemployment than inflation. Ever since the stagflation of the 1970s, inflation has been the chief priority of the Fed. Fed Chair Paul Volcker finally curbed the rampant inflation of
the 1970s during his tenure from 1979-1987, and set an example for future chairs. Senator Shelby and others predict Yellen will stray away from Volcker’s example.
But in fact it is not at all clear that Yellen would drift from the standard Fed priority of keeping inflation in check. Pethokoukis thinks that “having a chair who wants to put at least a thumb on the employment part of the scale is perfectly appropriate,” since “inflation is closer to one percent than the Fed’s target of two percent and unemployment is nowhere near its natural rate.” With inflation in check, the Fed has room to maneuver
to fight unemployment. Richard Wong, senior vice president and senior quantitative analyst at the Hartford Investment Management Company, thinks labeling Yellen as a dove is not entirely accurate, saying that Yellen “is a very even keel and sensible economist. She understands the dual mandate perfectly well.”
What’s Next
The top issue on the minds of economists and investors is when and how the taper of the Fed’s quantitative easing program will play out. Yellen and Bernanke are credited with being the chief architects of the Fed’s quantitative easing program. The program runs by the Fed buying massive amounts of capital assets to keep interest rates extremely low and to increase market liquidity. Over
the summer Bernanke announced that the Fed would possibly reduce the Fed’s purchases, or “taper” the program, later in the year, which caused a stir in the market and increased the interest rates on government bonds.
Ferguson explains that “you can’t move it or even taper [quantitative easing] without markets overreacting. We are only postponing the evil hour, the day of reckoning. But when it comes, my prediction is that the adjustment will be sharp, and the market response will be quite dramatic.” Despite the inevitable market reaction, Yellen is perhaps uniquely prepared to manage the taper, since she helped devise and implement the policy as vice chair under Bernanke.
A shift in economic circumstances and a new Fed chair will change the Fed’s grand strategy. Wong claims, “Ben Bernanke is a depression-era economist, but now that the days of the financial crisis have passed, the Fed chairmanship is a nice baton to hand over to Janet Yellen,” whose experience as a labor economist makes her “a healer of sorts.”
As the American economy continues its recovery, jobs will be the center of attention. Yellen’s focus on employment along with her record for technocratic, non-partisan governance will prove valuable. Increasing employment and managing the taper of quantitative easing will be extremely demanding. Nevertheless, Yellen brings continuity to the process after being the Fed’s vice chair and understands the complexity and scale of monetary policy today. On these counts, her nomination is the right pick for the right time.