President Obama today is expected to nominate Janet Yellen, who’s currently vice chair of the Federal Reserve, to succeed Fed chairman Ben Bernanke, whose term ends in January. The confirmation hearings in the Senate may prove to be rocky, given her critics among the hawks. In some respects, she’s more dovish than Bernanke. But her nomination, overall, would be a relatively safe choice, particularly at this point, given the uncertainty looming over the economy thanks to the budget battles in Washington and the potential for a Treasury default later this month if Congress doesn’t raise the debt ceiling. It doesn’t hurt that she topped the list for accuracy among Fed forecasters, according to a recent study by The Wall Street Journal (“Federal Reserve ‘Doves’ Beat ‘Hawks’ in Economic Prognosticating”).
Yellen, an economist who previously led the San Francsico Fed, isn’t shy about giving speeches and analyzing matters monetary and economic. In any case, the mystery factor about who she is and how she thinks is relatively low. With that in mind, let’s take a brief, selective and hopelessly subjective tour of what she’s said over the years. Let’s begin with her view of the business cycle as it relates to the Great Recession.
It is now clear that our system of regulation and supervision was fatally flawed. Despite volumes of research on financial market metrics and weighty position papers on financial stability, the fact is that we simply didn’t understand some of the most dangerous systemic threats. Looking back, I believe the regulatory community was lulled into complacency by a combination of a Panglossian worldview and benign experience. The notion that financial markets should be as free as possible from regulatory fetters had evolved into the conviction that those markets could, to a very considerable extent, police themselves. Meanwhile, things went along so well for so long that the common belief came to be that nothing could go disastrously wrong. Over a period of decades, the financial system was tested repeatedly–the Latin American debt crisis, the savings and loan crisis, the Asian crisis, the failure of Long-Term Capital Management, and the stock market crashes of the late 1980s and early 2000s. With each crisis, policymakers rolled up their sleeves and beat back the systemic threat. The levees held. Despite these financial market ups and downs, economies in the United States and other parts of the world performed very well. We appeared to have entered a new era of stability. We even gave it a name: the Great Moderation. We were left with the mirage of a system that we thought was invulnerable to shock, a financial Maginot Line that we believed couldn’t be breached. We now know that this sense of invincibility was mere hubris.
To understand what went wrong, I refer you to Hyman Minsky’s path-breaking work on speculative financial booms and busts. As Minsky showed, success can lead to excess, and excess to ruin. The Great Moderation saw a progressive growth of credit and extension of risk, which came to a head in the mortgage market. Credit flowed freely and cheaply, and households and financial institutions alike took on greater risk, borrowing to the hilt. House prices soared off the charts. Financial innovators found increasingly exotic ways of packaging loans for investors. Securities became so opaque that few understood their risks. Originators sold mortgages to investors whose due diligence consisted of glancing at ratings. The financial system became increasingly complex, interconnected, and hyperleveraged.
Speech, October 11, 2010
One potentially promising way to clarify the dependence of policy on economic conditions would be for the FOMC to frame the forward guidance in terms of specific numerical thresholds for unemployment and inflation. Such an approach was discussed by my colleague Charles Evans, president of the Federal Reserve Bank of Chicago, in a recent speech.5 Evans suggested that the FOMC could indicate its intention to continue holding the federal funds rate close to zero as long as the unemployment rate exceeds a given threshold, conditional on the medium-term inflation outlook remaining at or below a specified level.6 Such an approach could be helpful in facilitating public understanding of how various possible shifts in the economic outlook would be likely to affect the anticipated timing of policy firming. For example, if there were a further downward revision of the economic outlook, investors would recognize that the conditions for policy firming would not be reached until a later date and hence would have a more concrete basis for extending the time period during which they expect the federal funds rate to remain near zero.
Speech, October 21, 2011
I’ve already noted the turnaround in the job market. Unfortunately, I expect the pace of job creation to be muted, which is likely to leave unemployment stubbornly high for the next few years. My business contacts say that the overhead reductions and productivity improvements put in place during the recession have become permanent fixtures, which could be a factor restraining employment. My forecast calls for the unemployment rate to edge down to about 9¼ percent by the end of 2010 and still be about 8 percent by the end of 2011, a very disappointing outlook. This is a case in which I would be delighted to be proven wrong. I see inflation remaining subdued, a subject I’ll return to later.
Speech, April 15, 2010
It seems to me that a change in the conduct of monetary policy following the experience of the 1970s has probably caused inflation expectations to become better anchored, explaining why recent oil shocks have inflicted relatively little damage on the economy. This hypothesis could at least partly explain why the huge run-up in energy prices through the middle of last year was not accompanied by rising wage demands. That in turn enabled the Fed to follow an easier monetary policy that gave greater weight to the output effect of rising oil prices than would have otherwise been possible.
Speech, February 27, 2009
So, to summarize the outlook, while the economy did well in the second quarter, that strength is unfortunately likely to prove ephemeral. I anticipate sluggish growth in the second half of this year. Overall inflation over the past year has been unacceptably high. But, the prognosis for the not too distant future is favorable. The recent drop in commodity prices has improved the policy choice facing the Committee. However, going forward, it is clear that we must keep a close eye on both inflation and inflation expectations to ensure that we continue to earn the inflation credibility that we have built up over the past two and a half decades.
Speech, September 4, 2008