Yellen’s Legacy Burnished by Job Market Hunch, Crisis Policy Exit
Janet Yellen, the first woman to chair the Federal Reserve, may be entering the final stretch of a tenure defined by her deft navigation of the U.S. economy and the first steps toward exiting crisis-era policies that kept interest rates near zero for the better part of a decade.
President Donald Trump said in July that Yellen is “absolutely” in the running to remain at the helm of the U.S. central bank when her term expires in February. That doesn’t mean he’ll pick her, or that she even wants a second term. Yellen has declined to comment on the topic. The White House is also considering other candidates.
Whatever happens, the Yellen Fed has already had a far-reaching impact. Unemployment has fallen to around a 16-year low on her watch without sparking the runaway inflation that some feared. In fact, one of the most serious criticisms of her tenure may be that inflation has failed to rise as expected, and remains well below the Fed’s 2 percent target.
Yellen has also presided over the end of the Fed’s emergency-era bond purchases and mapped out a path to gradually shrink its $4.5 trillion balance sheet—both without repeating the market-roiling taper tantrum of predecessor Ben Bernanke. Some 71 percent of 42 economists in a Bloomberg News survey conducted Sept. 12-14 expect the Fed to announce when it will start the runoff at the conclusion of its meeting Wednesday.
Some of Yellen’s steps would be difficult for a successor to undo. What follows is a graphic look at Yellen’s legacy.
From the first moment she took office, Yellen let it be known that labor market improvement was a high priority.
“The unemployment rate represents millions of individuals who are eager to work but struggling to provide for themselves and their families,” Yellen said at her March 5, 2014, swearing-in ceremony.
In her first major speech as chair a few weeks later, Yellen indicated she was going to look at a broader set of labor market indicators.
She mentioned workers in part-time jobs that wanted full-time work, the number of voluntary quits, low growth rates in compensation and the share of unemployed who hah been out of work six months or longer.
“The pre-crisis Fed was of the belief that the unemployment rate served as an excellent proxy for labor market activity,” said Rob Martin, U.S. economist at UBS and a former member of the Fed Board staff. “She is the one that said, ‘Just because the unemployment rate is falling doesn’t mean there still aren’t a lot of people who were pushed outside of the labor market,’” he added.
Even after broader measures of labor market slack began to fall, Yellen captained a strategy that kept rate hikes at a very slow pace.
A key element in the gradual rate hikes—there have been only four in her term, so far—was the chair’s intuition that lower rates of unemployment would pull in more labor supply.
“She was practically a lone voice,” said Andrew Levin, a Dartmouth College professor and former adviser to Yellen. “By contrast, other Fed officials never even mentioned the possibility that a lot of people might rejoin the labor force as the economy strengthened.”
Labor force participation was in decline as aging baby boomers retired. Yellen gambled that some of that decline was cyclical, due to people being marooned without the right skills or opportunities after the recession.
The hunch was vindicated. People who weren’t participating in the labor force started to come back.
Yellen came into office in a time of expansion and hasn’t presided over a recession. All three of her predecessors did. But the job had its challenges. The economy was in transition to a new pattern of growth, and monetary policy had to be rethought to fit it.
Productivity, a measure of output per hour, was lower. Businesses in 2014 and 2015 were reluctant to invest. Credit was tighter. Inflation has missed the Fed’s 2 percent target during most of the past five years.
There were also shocks during her term, ranging from a slowing growth rate in China to an oil price bust.
“The models we have fit the Great Moderation; they didn’t fit this period,” said Jon Faust, an economist at Johns Hopkins University and former Fed Board adviser, referring to a period of low inflation and steady growth in the 1990s and 2000s.
Under Yellen, the Fed didn’t pre-judge the economy. In 2015 and 2016, the Federal Open Market Committee set aside the more aggressive rate-hiking assumptions it started with, raising just one time in each year.
“A hallmark of her regime has been exquisite patience,” said Nathan Sheets, the former director of the Fed’s international division who is now chief economist at PGIM Fixed Income. “This policy has generated hundreds of thousands, if not millions, of more jobs than we otherwise would have had,” Sheets added. “There is a real economic dividend.”
In June, nearly two dozen economists published a letter suggesting a review of the Fed’s 2 percent inflation target.
A month later, at her semi-annual congressional testimony, Yellen said the target is not under review.
Yellen is part of a generation of economists who came of age as inflation began to surge in the U.S. Altering inflation expectations looks risky to her.
“In general, they have been very inconsistent in their inflation message,” said Julia Coronado, president of Macropolicy Perspectives LLC in New York. “She does still have scar tissue from the inflation-conquering phase of central banking.” At the start of 2016, the FOMC clarified that its 2 percent inflation target was “symmetric,” meaning it would resist inflation that was too low, as well as too high.
The Fed has raised interest rates twice this year, with inflation still below target, counting on a tight labor market to push up compensation and then prices.
Low inflation “is a global story,” said Michael Gapen, chief U.S. economist at Barclays Capital. He said that the next round of central bank chiefs may need to strive for a deeper understanding of the inflation process and adopt a policy response.
The immediate risk is that if inflation remains low, interest rates remain low, and the Fed is likely to hit zero after a few cuts in the next recession. Further stimulus would again require bond purchases, which have been unpopular.
“Getting committee consensus around unconventional policy is much harder,” Coronado said.
An additional criticism of Yellen’s tenure is that the Fed’s steady campaign of greater transparency has slowed to a crawl. That may be because all the low-hanging fruit has been harvested.
Still, the Fed hasn’t explained well the distributional consequences, or economic drags, of new financial regulations that it and other regulators have put in place.
“Regulatory goals conflicted with monetary policy, and they didn’t want to recognize that in a forthright way,” Gapen said.
After sparring with Congress for years over monetary policy rules, only this past January did the Fed include a special presentation in its monetary policy report on the topic. Earlier engagement might have mitigated House legislation which, in effect, calls for an audit of Fed monetary policy decisions.
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