Yellen’s Focus on Unemployment Adopted by FedCraig Torres and Joshua Zumbrun
Federal Reserve Vice Chairman Janet Yellen has fought for more than a decade to put attacking unemployment and boosting growth on an equal footing with fighting inflation at the heart of the Fed’s policy.
After years on the periphery, she now finds herself at the center of the prevailing view at the Fed and at central banks around the world, just as the spotlight swings to her as a potential successor to Chairman Ben S. Bernanke.
“The philosophy of Janet Yellen is activism of government policy to achieve objectives,” said Allen Sinai, president of Decision Economics Inc.
Speculation about the succession at the central bank intensified after the Fed said this week that Bernanke would skip the central bank’s annual symposium in Jackson Hole, Wyoming, because of a personal scheduling conflict. The 59-year-old Bernanke, whose term expires in January, has been the keynote speaker every year since becoming chairman in 2006.
Yellen, a 66-year-old former professor at the University of California, Berkeley, would be the first woman Fed chairman in its 100-year history should she succeed Bernanke.
Bernanke has repeatedly declined to comment on his plans after the end of his term in January. At a March 20 press conference, he said that he’s “spoken to the president a bit” about his future and that he feels no personal responsibility to stay at the helm until the Fed winds down its unprecedented policies to stimulate the economy.
Bernanke’s comments in March jibed with the views of some of President Barack Obama’s economic and political advisers who have said Bernanke, after spending most of his seven years on the job fighting a financial crisis and its aftermath, is exhausted and wants to return to private life.
In his battle against the financial crisis and slow recovery, Bernanke has become an aggressive activist, bringing him closer to Yellen’s view that government policies can smooth over the ruts of market economies.
The Fed’s first two rounds of quantitative easing were out of a standard playbook of monetary policy -- offsetting illiquid financial markets and stopping too-low inflation. By contrast, the third round begun in September is aimed explicitly at lowering unemployment.
Changes in the benchmark lending rate, which has been near zero since December 2008, are now explicitly linked to achieving lower rates of joblessness so long as inflation forecasts remain no higher than 2.5 percent. That step in Fed communications arose in discussions by Yellen and other FOMC members as early as a meeting in August 2011.
“Members also considered conditioning the outlook for the level of the federal funds rate on explicit numerical values for the unemployment rate or the inflation rate,” according to minutes from the gathering. “Some members argued that doing so would establish greater clarity regarding the committee’s intentions.”
Yellen’s writings and speeches show confidence in government’s ability to offset calamities, especially in labor markets. In 2004, as president of the San Francisco Fed, she argued in a paper written with her Nobel Prize-winning husband, George Akerlof, that central bankers couldn’t ignore the high costs of long-term joblessness.
“Policy makers should be compelled to take action given the serious costs of long-term unemployment when overall unemployment is already high,” they wrote. “A week of unemployment is worse when it is experienced as part of a longer spell.”
The proportion of the unemployed who have been out of work for 27 weeks or longer was 39.6 percent of the total last month, compared with a record 45.3 percent in March 2011 and 17.4 percent when the recession began in December 2007.
Bernanke, in a press conference last December, echoed some of Yellen’s concern with the plight of the unemployed.
“The conditions now prevailing in the job market represent an enormous waste of human and economic potential,” Bernanke said on Dec. 12, after a meeting of the Federal Open Market Committee.
Yellen, who was born in Brooklyn, New York, studied economics at Brown University in Providence, Rhode Island. She received her PhD from Yale University in New Haven, Connecticut, in 1971, where a professor, James Tobin, promoted Keynesian economics.
“The perspective of those who studied with Tobin at Yale was that the government has an affirmative responsibility to offset the instabilities of the private economy,” said James Galbraith, another Yale PhD who worked on the Humphrey Hawkins Act of 1978, which affirmed the Fed’s obligation to pursue stable prices and maximum employment.
Yellen became an assistant professor at Harvard University and later took a job in the Fed’s international division. There she met Akerlof, whom she married in July 1978. After a two-year stint at the London School of Economics, they settled into jobs at the University of California, Berkeley.
Together they wrote about a dozen papers on the intricacies of the labor market. Their most-cited work, according to the website Research Papers in Economics that tracks citations, demonstrated that whether workers believe they are paid fairly influences their efforts on the job and even helps explain the national unemployment rate.
“There was a rip-roaring debate during the time we were at Berkeley -- in a way it continues to this day -- about the nature of unemployment and what can be done to address it,” Yellen said in an interview in September.
She became president of the San Francisco Fed in June 2004 and vice chairman of the Washington-based Board of Governors in October 2010.
In an April 1999 speech at Yale, Yellen argued for activist policies.
“Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not,” she said. “Are deviations from full employment a social problem? Obviously.”
“Although most Americans apparently loathe inflation, Yale economists have argued that a little inflation may be necessary to grease the wheels of the labor market and enable efficiency-enhancing changes in relative pay to occur without requiring nominal wage cuts by workers,” she said.
By contrast, Bernanke’s work on the Great Depression as a graduate student at the Massachusetts Institute of Technology and a professor at Princeton University focused on how policy errors by central banks can exacerbate downturns.
Under his chairmanship, the Fed has taken a further step, toward “playing a role in offsetting what is clearly a reticence” by households and businesses to consume and invest, said Galbraith, now an economist at the University of Texas at Austin.
In his first speech as Fed chairman in February 2006 at Princeton, Bernanke said stable prices are the “means by which policy can achieve its other objectives.”
Bernanke’s work on inflation targeting has its roots in rational expectations, a school of economics pioneered by Nobel-prize winning economist Robert Lucas Jr.
Rational expectations models assume near-complete information among households and businesses and thus efficient decision making. Government intervention, policy errors and opaqueness get in the way of efficient price setting, the allocation of credit and investment.
“When monetary policy makers set a low rate of inflation as their primary long-run goal, to some significant extent they are simply accepting the reality of what monetary policy can and cannot do,” Bernanke wrote in a 1999 book along with co-authors Adam Posen, a former Bank of England Monetary Policy Committee member, Columbia University economist Frederic Mishkin and Fed Board economist Thomas Laubach.
“In the long run, the central bank can affect only inflation, and not real variables such as output,” they wrote.
As early as 1995, when she was a Fed governor, Yellen was discounting this notion of the primacy of the inflation goal, saying both objectives -- maximum employment and low and stable inflation -- needed to be pursued in a balanced way.
“When the goals conflict and it comes to calling for tough trade-offs, to me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target,” she said during a debate on inflation targeting in 1995.
The movement of central banks toward boosting growth marks a shift in thinking prompted by the financial crisis, said Posen, president of the Peterson Institute for International Economics in Washington.
In late 2010 and early 2011, central bankers began to confront the risk that if demand didn’t pick up, millions of workers and idle capital -- ranging from computers to factories -- wouldn’t be productive again, Posen said in an interview. Households and businesses would reduce their expectations for the speed of economic growth. Also, there was the risk the public would see monetary policy as having less clout, he said.
Facing this threat, Bernanke and Yellen “converged,” Posen said. Swinging policy toward the labor market, so long as inflation was contained, hinged on communicating the potency of policy and putting as much emphasis on fighting unemployment as on ensuring price stability.
In December 2012, the FOMC put Yellen’s prescription from nearly two decades ago into action and said that it would keep its target interest rate at zero until unemployment fell to 6.5 percent, so long as the outlook for inflation did not breach 2.5 percent -- a rate above its 2 percent target declared in January that year.
The Fed was also making a “political statement,” according to Posen. “The Fed said, ‘Yes, we are doing this. This is our mandate’ and they needed to do so for democratic accountability.”