Yellen Fighting for Job Growth Doesn’t Give Ground on Inflation
In the contest between competing schools of economics, Federal Reserve Vice Chairman Janet Yellen has woven her own path.
While viewed by some on Wall Street and Capitol Hill as a dove on monetary Policy, the designated successor to Chairman Ben S. Bernanke resists those, like International Monetary Fund Chief Economist Olivier Blanchard, who suggest that aiming for a higher inflation target than the current 2 percent would give policy makers more flexibility in setting interest rates.
She also favors the Fed’s aggressive expansion of its balance sheet to help steer the economy back to full employment, challenging skeptics, such as Richmond Fed President Jeffrey Lacker, who say the costs of such actions now outweigh the benefits.
“Janet Yellen would be a vigorous proponent of the dual mandate,” said Nathan Sheets, former head of the Fed’s Division of International Finance, referring to the goals of maximum employment and stable prices Congress set for the Fed. “The quest to appropriately balance the legs of the dual mandate, in the face of a disappointing recovery, is the primary challenge that Yellen would face” as Fed chairman.
Obama will announce the nomination at 3 p.m. today at a ceremony attended by Yellen and Bernanke, whose term expires on Jan. 31, a White House official said in an e-mailed statement.
Yellen, 67, voices confidence in the ability of monetary policy to stabilize output and boost employment when capitalism fails, a view she shaped under the late Nobel laureate James Tobin at Yale University in New Haven, Connecticut, where she obtained her Ph.D.
She also holds that aggressive monetary stimulus only works if inflation is anchored around the central bank’s target of 2 percent, a view informed by the rational-expectations work of Robert Lucas, a University of Chicago economist who won the Nobel Prize in 1995. Economic models based on rational expectations assume that a credible inflation goal becomes ingrained in consumer and business decision-making, thus helping policy makers hit their target.
While Yellen might run policy “exceptionally easy” in an effort to win more labor-market gains, she has also highlighted in speeches “that there is scope for such policies only if inflation does not rise much above its target,” added Sheets, who is now global head of international economics at Citigroup Inc. in New York.
Yellen’s day-to-day policy work combines analysis of current economic data with mathematical rigor, said Joseph Gagnon, a former Federal Reserve Board economist. In her speeches, she frequently refers to models and simulations.
“She is very mainstream,” said Gagnon, now a senior fellow at the Peterson Institute for International Economics, a non-partisan Washington research group. Monetary policy “will be contiguous” with the past eight years under Bernanke, 59.
Yellen has spent almost a dozen years as a policy maker at the central bank, half of that as president of the Federal Reserve Bank of San Francisco.
Her rise to the top began when she took a job as a staff economist in the Fed’s division of international affairs in 1977. There she met another young economist named George Akerlof. They married in 1978, leaving the Fed that year, first for the London School of Economics and then for the University of California at Berkeley.
Work on labor economics became a hallmark of her career. She and Akerlof were co-authors of more than a dozen papers that delved into the mechanics of how people switch jobs and what it means when workers perceive their wages as unfair.
Her immediate task as chairman would be to bring inflation and employment closer to the central bank’s congressionally mandated goals.
Price increases decelerated to a 1.2 percent 12-month pace in August from 1.3 percent the previous month and have been half a percentage point or more below the Fed’s 2 percent goal since November. The August unemployment rate of 7.3 percent compares with the 5.2 percent to 5.8 percent rate that the Fed views as representing efficient labor resource use.
For now, Yellen is likely to continue using the same tools that Bernanke wielded -- and she helped design -- to achieve the dual mandate, possibly with a different view on how long to continue them, said Antulio Bomfim, senior managing director in Washington with Macroeconomic Advisers LLC.
U.S. central bankers in December increased their bond purchases to an $85 billion monthly pace while tying changes in the benchmark lending rate to thresholds for unemployment and inflation. The Fed said it will keep the federal funds rate, the overnight lending rate between banks, in a range of zero to 0.25 percent so long as unemployment is above 6.5 percent and inflation is forecast to be no higher than 2.5 percent.
Yellen was involved in developing the thresholds, and pushed for having the Federal Open Market Committee commit to an inflation target before the panel adopted these as policy guidelines.
The FOMC in January 2012 said for the first time its target for prices was a 2 percent annual increase. Yellen led the subcommittee that built consensus around the goal and stood behind a phrase in the panel’s policy goals document that said anchoring the public’s views on inflation “enhances the committee’s ability to promote maximum employment in the face of significant economic disturbances.”
In Wall Street parlance, Yellen is viewed as a “dove” or a policy maker who is more permissive on inflation and tilted toward boosting employment. Michael Feroli, chief U.S. economist for JPMorgan Chase & Co., placed Yellen at that end of the FOMC’s policy spectrum, along with Fed presidents Charles Evans of Chicago, Eric Rosengren of Boston, and Narayana Kocherlakota of Minnesota. Economists who have worked with her, though, say she would follow a balanced approach and would be an aggressive defender of the 2 percent goal.
She doesn’t support Blanchard’s suggestion, in a 2010 paper with two other IMF economists, that a 4 percent inflation target might provide a better buffer against deflation and give policy makers more flexibility to lower the federal funds rate. The rate typically is higher than the inflation rate. So, with 4 percent inflation, the benchmark might be 6 percent, giving policy makers more room to cut before hitting zero.
The idea hasn’t died. Laurence Ball, an economist at Johns Hopkins University in Baltimore, wrote a paper in April titled: “The Case for Four Percent Inflation.”
At the same time, Yellen may be less worried than some of her fellow FOMC participants about the cost of further expanding the Fed’s $3.75 trillion balance sheet. In a March speech, she listed four potential risks a rising balance sheet might entail: It could impair market functioning, create difficulty in removing stimulus, lead to balance-sheet losses when assets are sold, and pose risks to financial stability, such as inflating asset bubbles or driving investors into high-yield investments of lower credit quality. She dismissed all of them.
“She seems to have higher tolerance than Bernanke in terms of quantitative easing, likely seeing a more favorable cost-benefit tradeoff,” said Bomfim, a former Fed Board economist. “But less concerned doesn’t mean not concerned,” he added.
Yellen did add an asterisk to one of the risks.
“Financial stability concerns, to my mind, are the most important potential cost associated with the current stance of monetary policy,” she told the National Association for Business Economics in Washington March 4.
Yellen now has a staff designated to watch for financial risk. The Office of Financial Stability Policy and Research, which Bernanke established in 2010, reports to the vice chairman.
On the effectiveness of the asset purchases, Yellen said in the March 4 speech there is “considerable evidence” that the purchases, by keeping longer-term rates low, “have presumably increased interest-sensitive spending.”
That follows from her “Yale paradigm” perspective, as she described the influence of Tobin on economists who studied at Yale. Tobin, who was in his teens during the Great Depression, held that the failures of capitalist economies during that period “were root causes” of global political and social upheaval.
“Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not,” she said in a 1999 speech in New Haven on Yale economics. “On the question of whether monetary and fiscal policy can succeed in moving the economy toward full employment, Yale answers yes in both cases.”
Other participants on the FOMC, such as Charles Plosser, the Philadelphia Fed president, and Richmond’s Lacker, have voiced greater concern that aggressive monetary policy could create distortions now that would harm growth over the longer run.
“Efforts to drive real rates more negative or promises to keep rates low for a long time may have frustrated households’ efforts to rebuild their balance sheets without stimulating aggregate demand or consumption,” Plosser said in Rochester, New York, Jan. 15.
Lacker dissented against the decision to boost asset purchases last December when he was an FOMC voting member, saying they were “unlikely to add to economic growth without unacceptably increasing the risk of future inflation,” according to minutes of the meeting. Presidents of the Fed’s district banks rotate as voting members on the committee, except the New York Fed president, who has a permanent vote.
Macroeconomic Advisers envisions the economy expanding at a 3.25 percent annual rate in the second half of next year, with unemployment falling to about 7 percent by then. If that forecast pans out, Yellen would probably end the asset-purchase program “early in the second half of next year,” Bomfim said.
Right now, continuing aggressive stimulus is “a straightforward call: because of the nature of the recession and slow recovery, the Fed is missing on both sides of its mandate,” said Richard Clarida, a former assistant Treasury secretary who is now an executive vice president at Pacific Investment Management Co. in Newport Beach, California, and professor of economics at Columbia University in New York.
Yellen “has to be careful to lay out what the optimal policy would look like while defending the 2 percent inflation target,” he added. “I think she will be a very credible central banker.”
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