Is Yellen a Hawk in Dove's Feathers?
If you want to know what Janet Yellen might be like as the head of the Federal Reserve, look at 1996.
Attention has focused on Yellen's tenure as the Fed's vice-chair since 2010. But she was also a Fed governor from 1994 to 1996 when the economy was healthy. If she gets the nod, she would probably stick around until 2018, when forecasters in the private sector and the Fed expect the economy to be back at full employment. So the earlier period, rather than her handling of the crisis, might tell us more about how she would steer the Fed.
In fact Yellen was hawkish -- surprisingly so for someone often called a dove. People who expect Yellen to lean toward easy money may be surprised by how ready she is to tighten policy when the time is right. Transcripts from the Fed's 1996 meetings show what Yellen cares most about: whether unemployment is above or below a rate consistent with stable inflation over the long run, a level that goes by the ungainly acronym NAIRU (non-accelerating inflation rate of unemployment). She mentioned it multiple times in every meeting that year.
When unemployment is higher than NAIRU, as it is now, Yellen sounds like a dove. But when unemployment falls below, as it did in 1996, Yellen has shown she's more ready to tighten policy than other central bankers. It seems she favors stronger responses to deviations, whatever the direction. In the language of monetary policy's Taylor rule, Yellen puts a heavier weight on unemployment.
Hear her go hawk:
"Clearly, we have an economy operating at a level where we need to be nervous about rising inflation," Yellen said in May 1996. "This is a major risk. Obviously, we need to be vigilant in scrutinizing the data for signs of rising wages and salaries." The unemployment rate was then 5.3 percent.
"We may be living on borrowed time, and there may end up being a price to pay for having allowed" unemployment to go too low, she said that July. Unemployment rate: 5.5 percent.
"To my mind, labor markets are undeniably tight," Yellen said in her last Fed meeting in December, with unemployment at 5.4 percent. "We should be careful not to lull ourselves into a false sense of security about incipient wage pressures."
Sound like a dove? I didn't think so. It's not in the Fed transcripts, but Yellen also threatened to dissent from Fed statements in favor of tighter policy in 1996. Under Alan Greenspan's chairmanship, dissents were rarer, so this was a big deal. Other members of the monetary-policy committee were less inclined to tighten policy, even though they recognized unemployment was below the NAIRU. She was just more aggressive about it.
Yellen turned out to be wrong about the risk of inflation in 1996. Low unemployment did not lead to upward pressures on wages. Unemployment kept falling for three more years, all the way to 3.8 percent in 2000.
Her explanation? The normal unemployment rate had declined. Workers had less bargaining power than in the 1970s, due to a globalized economy, weaker unions and lesser legal protections. That gave the economy more breathing room before tight labor markets would have set off a wage-price spiral.
1996 shows how important it is to understand Yellen's background in the economics of the labor market. It's central to how she sees the economy and how she would lead the Fed -- just as Ben Bernanke's academic training in money, finance and the Great Depression gave him a rationale, the "portfolio-balance channel," for quantitative easing.
One more sophisticated version of the argument that Yellen is a dove draws on a debate the Fed had in 1996 over its long-run goal for inflation. Some wanted the Fed to aim for "price stability" in the form of zero inflation. Yellen didn't. She made and won the case for slow, stable inflation.
"Dove!" you may cry. But her reason wasn't to boost growth, the usual dovish line. Her argument came down to pure labor economics: Workers resist cuts in the dollar amount of their pay, so some inflation makes it easier to bring the real value of wages back down if they have risen too far.
The claim that Yellen is always a dove is often made but never substantiated. It can't be. She's not.
(Evan Soltas is a contributor to the Ticker. Follow him on Twitter.)