Midway through Janet Yellen’s first year as Federal Reserve chair, consumer prices were rising at the fastest pace in 19 months and some Wall Street economists started asking how long she would be able to maintain the lowest interest rates since the Great Depression to fulfill her goal of full employment.
Yellen wasn’t fazed. At a June press conference, she said the increase in the consumer price index was likely to be temporary. “Data that we’re seeing is noisy,” she said, and broadly in line with the expectations of the policy-making Federal Open Market Committee. The next month, the CPI started to drop.
“She accurately interpreted what was going on behind the inflation data,” said Tim Duy, an economics professor at the University of Oregon in Eugene and a former U.S. Treasury Department economist. “It proved to be very insightful.”
The first woman to lead the central bank of a major developed economy, who completes her initial year on the job Feb. 3, proved to be a master of math forecasting economic data as she ended asset purchases in October and set up the first increase in the federal funds rate since 2006 without destabilizing global markets.
“She’s had an excellent track record as chair in a very demanding time,” said Dana Saporta, a U.S. economist at Credit Suisse Group AG in New York. “To date she’s had success in avoiding any sort of market tantrum.”
The Standard & Poor’s 500 Index closed at a record on Dec. 29 for the 53rd time in 2014 and the dollar had its best year since at least 2005. Treasuries returned the most since 2011.
Reading the economy correctly and getting forecasts right are crucial to managing a smooth exit from the Fed’s unprecedented stimulus. Unexpected shifts can roil markets and undermine monetary policy, as shown by the jump in borrowing costs in mid-2013 when then-Chairman Ben S. Bernanke told lawmakers the Fed may slow bond buying “in the next few meetings.” The comment rattled investors worldwide and spurred a surge in bond yields that became known as the taper tantrum.
The stakes are even higher for Yellen, 68, as she prepares investors for rising interest rates. So far she’s managed to end the large-scale asset purchases that pushed the Fed balance sheet to a record $4.51 trillion last month. She also eliminated guidance linking interest-rate increases to the level of unemployment, and later avoided missteps in dropping the pledge to keep rates low for a “considerable time” after the conclusion of bond buying.
Offering her interpretation of that language in March, Yellen said: “It probably means something on the order of around six months or that type of thing. But, you know, it depends.”
That comment at her first press conference as Fed chair prompted questions about whether she really intended to be so specific, with her performance portrayed in some commentary as a rookie mistake.
Now, her estimate has a growing consensus, with other policy makers saying rates could rise in mid-2015.
Fed Vice Chair Stanley Fischer and New York Fed President William C. Dudley say market expectations of liftoff around mid-2015 are reasonable. Atlanta Fed President Dennis Lockhart’s call is for mid-year or later, while St. Louis Fed President James Bullard focuses on the end of the first quarter.
Yellen declined a request to comment through spokeswoman Michelle Smith.
San Francisco Fed President John Williams, Yellen’s research director at the bank before succeeding her in 2011, says her forecasting comes from more than just models. Nor does it rely solely on economic theory derived from James Tobin, Robert Solow, Paul Samuelson and John Maynard Keynes, who had the biggest influence on American economics in the 20th century.
Williams said she also draws on her experience at the reserve bank, where she honed her projections by speaking regularly with business leaders, and she still tests her own forecasts and beliefs by listening to others, especially when their views challenge her own.
Yellen is the first Fed chief since Paul Volcker who has also been chief executive of an organization on the scale of the San Francisco reserve bank, managing 1,500 employees and supervising a district that constitutes one-fifth of the U.S. economy. She ran the San Francisco bank, one of the 12 in the Federal Reserve System, for six years and also spent two-and-a-half years as Fed governor and three years as Fed board vice chair. Volcker became Fed chairman in 1979 after four years at the head of the New York Fed.
“She just starts in her mind with how things connect,” Williams said in a December interview. “With an economy with hundreds of millions of people and a global economy, this all makes sense to her.”
Yellen talks to other economists, listening closely to “what other people are saying that might be a dissonant voice from what we maybe were already thinking,” Williams said.
Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC in New York, said Yellen also deserves credit for correctly identifying risks in global growth, U.S. housing, and, in the years leading up to the financial crisis, the growing threat that a recession was nearing.
“She has a very good track record,” Dutta said. “She was right.”
Yellen’s forecasts are holding up better than those of former Treasury Secretary Lawrence Summers, who was a leading candidate to succeed Bernanke. Summers withdrew his name from consideration amid opposition from Senate Democrats. In December, he reiterated his warning that the U.S. could be mired in an extended period of little or no economic growth, also known as secular stagnation.
That was before revised government figures showed the world’s largest economy grew at a 5 percent annualized pace in the third quarter, the fastest since 2003.
Summers remains skeptical. “Just because we have 5 percent growth doesn’t mean we are out of the woods,” the former Treasury secretary told the American Economic Association meeting in Boston Jan. 3. He cited the risk of financial bubbles.
Yellen can point to the recovery of the labor market in the U.S., which last year posted the biggest employment gains since 1999. The unemployment rate dropped to 5.6 percent in December from 6.7 percent when Yellen took office in February.
Keeping up that kind of performance would bring the first interest-rate increase since 2006 into view sooner. Yellen told reporters Dec. 17 that the Fed will be “patient” in deciding when to raise rates and is unlikely to move for the “next couple of meetings.” She said that means at least until the April 28-29 meeting. That would be exactly six months after the end of the asset purchases. The following FOMC meeting, on June 16-17, would be seven months and two weeks after quantitative easing ended.
Economists expect the first rate rise at the June meeting. Forty percent said that’s the most likely date for the increase, while 21 percent expect September and 10 percent said July, according to a Bloomberg survey conducted in early December. The federal funds rate has been held near zero since December 2008.
That year, as policy makers struggled to interpret the weakening economy, Yellen correctly judged that it was “at, if not beyond, the brink of recession,” according to the transcript of the January 2008 FOMC gathering.
Yellen, then president of the San Francisco Fed, spoke after the Fed staff reported that the economy wasn’t in a recession, though the likelihood of a downturn was increasing. As it turned out, the U.S. had already been in a recession for almost two months, according to subsequent findings of the National Bureau of Economic Research, the official arbiter of U.S. business cycles.
While Yellen has shown forecasting savvy, she’s been less deft in her relationship with Capitol Hill, where Republicans taking control of the Senate this year threaten more scrutiny of the central bank’s monetary and regulatory policies. Lawmakers in both parties plan to introduce bills that would restrict the central bank.
Alabama Republican Senator Richard Shelby, who voted against Yellen’s nomination as vice chair in 2010 and as chair in 2013, is in line to head the Banking Committee. He’s said in the past he had “deep concerns about Dr. Yellen’s Keynesian bias toward inflation.”
Yellen, a labor-market economist and professor at the University of California at Berkeley before joining the Fed, met in November with labor and community organizers who say they want her to keep rates low to help the unemployed. She said in an October speech that she’s “greatly” concerned by the most sustained rise since the 19th century in the inequality of Americans’ incomes and wealth.
Unemployment has been a primary focus for Yellen since she graduated summa cum laude from Brown University and received her doctorate in economics from Yale University. In 1990, she was the co-author with her husband, George Akerlof, who received the 2001 Nobel Prize in economics, of research showing that lower wages can lead to higher unemployment.
At the Fed, Yellen has proven to be less dovish than some of her critics expected. At her December press conference, Yellen said policy makers were prepared to raise rates in 2015, even though inflation may be “running close to its current level” or even lower.
“As long as participants feel reasonably confident that the inflation projection is one where we expect to meet our 2 percent objective over time, that’s what I think how they’ll be looking at things as we decide on the path for the funds rate,” she said. “I want to emphasize that no meeting is completely off the table,” she said, and “there is no preset time.”
Renaissance Macro’s Dutta said in a subsequent report that Yellen “revealed herself to be a traditional central banker with conventional policy considerations” and she’s “not the uber dove she is often portrayed to be.”