Yellen Anti-Inflation Credentials Defended by Gramley, Blinder

Janet Yellen
Janet Yellen, president of the Federal Reserve Bank of San Francisco, speaks at the University of San Diego's Joan Kroc Institute for Peace and Justice in San Diego, California. Photographer: Sandy Huffaker/Bloomberg

When Janet Yellen was first reported to be President Barack Obama’s choice for Federal Reserve vice chairman early last month, the dollar weakened on speculation she would help keep interest rates at a record low through the end of the year.

Less than two weeks later, the former professor at the University of California, Berkeley told reporters that she’d be ready to tighten policy to avoid kindling inflation. She pointed out that she had supported interest-rate increases 20 times in her years as a Fed governor from 1994 to 1997 and as president of the San Francisco Fed starting in 2004.

“The Fed has to be ready to take away the punch bowl when it’s necessary,” Yellen, 63, said after a speech on March 23. “When the time has come, am I going to support raising interest rates? You bet.”

Investors should take her words at face value, say economists including Lyle Gramley, a former Fed governor, and Alan S. Blinder, a former vice chairman.

“When inflation pops its ugly head up, Janet will be there as strongly anti-inflationary as anybody on the committee,” said Gramley, a senior economic adviser for Potomac Research Group in Washington.

Obama yesterday announced he will nominate Yellen to the Fed’s seven-person Board of Governors, along with Sarah Bloom Raskin, Maryland’s commissioner of financial regulation, and Peter Diamond, an economics professor at the Massachusetts Institute of Technology.

‘Extended Period’

Yellen, if confirmed by the Senate, would join the Fed board as it considers when to signal an end to its policy of keeping interest rates low for an “extended period.” The Federal Open Market Committee this week renewed that pledge, prompting Kansas City Fed President Thomas Hoenig to dissent for a third straight meeting, saying the language limits the Fed’s ability to increase rates “modestly.”

The Brooklyn-born economist would replace Donald Kohn, a 40-year veteran of the central bank. She would preside over board meetings in Chairman Ben S. Bernanke’s absence and get a permanent vote on monetary policy, instead of having a vote one year out of every three as a regional Fed chief. Yellen would have a four-year term as vice chairman and a separate term as a governor.

Yellen, in a statement yesterday, said she’s “strongly committed” to the central bank’s dual mandate from Congress to keep inflation low and stable while promoting maximum employment.

Job Creation

“If confirmed, I will work to ensure that policy promotes job creation and keeps inflation in check,” Yellen said.

In an April 15 speech, Yellen said she’s increasingly certain the U.S. economy is “on the right track,” and that officials will “at some point” need to lift borrowing costs. Still, “it’s important not to lose sight of just how fragile this recovery is,” she said.

Policy makers are contending with an unemployment rate that has been stuck at 9.7 percent for three straight months even as payrolls started to grow. Fed officials this week repeated that inflation is likely to be “subdued” and that consumer spending is held back by tight credit and weak income growth.

U.S. central bankers have kept the benchmark lending rate in a range of zero to 0.25 percent since December 2008. Their purchases of $1.25 trillion in mortgage-backed securities, which ended last month, boosted the balance sheet to a record $2.34 trillion, creating concern among some officials that aggressive monetary stimulus could lead to imbalances later.

Growth Forecast

Gross domestic product grew at a 3.3 percent annual pace in the first quarter, according to the median forecast of economists surveyed by Bloomberg News ahead of a report today from the Commerce Department. After a 5.6 percent expansion in the prior three months, such growth would mark the best back-to-back performance since the last six months of 2003.

Conditions in financial markets have also improved. Raytheon Co., the world’s largest missile maker, and the finance unit of Royal Dutch Shell PLC led a drop in U.S. industrial company debt yields to 129 basis points more than similar-maturity Treasuries last week, according to Bank of America Merrill Lynch index data.

Yellen spent most of her career teaching economics and researching labor markets, joining the University of California at Berkeley in 1980. She and her husband, George Akerlof, a Nobel Prize-winning economist, have written more than a dozen papers that included studies on unemployment, wages, street gangs and out-of-wedlock births.

Goes to Washington

In 1994, then-President Bill Clinton appointed Yellen to be a Fed governor in Washington, where she served until 1997, when she was moved to the White House to chair the Council of Economic Advisers. She left the position in 1999 to return to Berkeley.

“You can’t put her in a box,” said University of California professor Aaron Edlin, who has known Yellen for 22 years and worked with her on the Council of Economic Advisers. “If dove means she cares about people who are unemployed, I suppose you can say she’s a dove. But it’s not the case that she doesn’t care about inflation.”

Yellen rejoined the Fed in 2004 as president of its San Francisco district bank, which represents the largest region by area and economic output. In her years as a policy maker, she has never dissented from the FOMC’s majority on an interest-rate decision.

Rate Risks

In April 2006, Yellen became the first Fed official to warn about the risks of raising the overnight lending rate between banks too far. Her remarks foreshadowed an end to a two-year long campaign to lift the federal funds rate in quarter-point increments from a low of 1 percent. The committee stopped at 5.25 percent after its June 2006 meeting and left borrowing costs at that level for more than a year.

“Janet’s very cognizant of the dangers of overstaying tightening or easing because of the failure to take into account long lags in policy,” said Blinder, a co-author of a 2001 book with Yellen called “The Fabulous Decade: Macroeconomic Lessons from the 1990s.”

Then, in a September 2007 speech in San Francisco, Yellen appeared to signal another shift, saying that the U.S. economy was under “significant downward pressure” from turmoil in credit and housing markets. The Fed lowered the fed funds rate target a week later by a half point to 4.75 percent, the first cut in four years, to protect the U.S. from sinking into a recession.

“If I were on the board right now, I would be as dovish in my remarks as she is,” Gramley said. “I don’t worry about her dovishness. She is an intellectual powerhouse. She has the enormous respect of her colleagues. She’s going to be a huge asset as the vice chairman of the Fed.”