Yellen Assumes Office With Weight of QE on Her Shoulders
At 9 a.m. Eastern on Monday morning, Janet Yellen was sworn in as chair of the Board of Governors of the Federal Reserve System, an oath administered by Daniel Tarullo. President Barack Obama nominated Yellen for the position in October, and the ceremony — as well as the very real transfer of power that it represents — concludes a four-month confirmation process. Yellen takes the title of chair from Ben Bernanke, who took office in 2006.
In November, following her nomination, Yellen sat before the Senate Banking Committee to answer questions about how she intended to posture herself as Fed chair should the Senate confirm her. Facing direct, usually mild but sometimes pointed questioning from policymakers with a fairly diverse array of positions on the Fed and monetary policy, Yellen was steadfast. She championed the strong ideas and good character that has won her many supporters, calling for an independent Fed, defending the efficacy of quantitative easing, and expounding on the role of the Fed as financial regulator.
With the confirmation, the conversation surrounding monetary policy in the U.S. has shifted toward Yellen and how she will lead the decision-making process at the Fed. Yellen is a Democrat and appears to lean to the dovish side of the spectrum as far as monetary issues are concerned. Although hawks have increased their volume in recent months, doves still rule the roost at the Fed.
Yellen made a comment in 1995 that has been widely touted as evidence of her position in the eternal debate between unemployment and inflation, which lies at the heart of the dove-versus-hawk debate. (Doves tend to be more concerned with unemployment while hawks generally place inflation concerns first.)
In 1995, as the economy continued to expand in the wake of the recession that ended in 1991 and the so-called “new economy” was developing, then-Chair Alan Greenspan led the Federal Open Market Committee (Yellen was on the Board of Governors at the time) in a debate about inflation targeting.
Yellen argued that unemployment could also be used as a target — and may even be a preferable target — over inflation when it is impossible to pursue both in harmony. “When the goals conflict and it comes to calling for tough tradeoffs,” she said in 1995, “to me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target. … When I look at the behavior of the FOMC and other central banks, I simply can’t find a lot of cases in which monetary policy has ever been driven by an exclusive focus on inflation performance.”
The thinking revealed by her comment is particularly relevant to the Fed’s current monetary strategy. Targeting, in the form of forward guidance, has come to dominate the conversation, and the unemployment threshold was edited when the taper was announced.
The taper — which first reduced the flow rate of QE3 asset purchases from $85 billion to $75 billion per month, and later to $65 billion per month — was a landmark event. Its significance comes in two flavors. The first is how the actual reduction in purchases will affect financial markets and, through them, the economy; the second is how the evolving policy will affect the expectations of market participants.
The markets avoided a tantrum when the taper was first announced, but the second stage of the reduction appeared to cause some tremors. To date, the taper has served as medication (part pain killer, part stimulant) for financial markets that were severely damaged during the crisis. Like with any strong medication, it can be habit-forming and needs to be weened as recovery takes place. This combination can cause some problems, which manifested with the second taper announcement.
The defining feat of Yellen’s first year or so in office will be her management of the rest of the taper. There appears to be a consensus that QE asset purchases must be wound down, but this process is risky, as demonstrated by the second taper announcement. Yellen will have to juggle both the real economic impact of the taper and the expectations and sentiment of the market as she proceeds.