In more than three hours of testimony before the House Financial Services Committee on February 11, new Federal Reserve Chair Janet L. Yellen laid out a monetary policy blueprint very similar to that of her predecessor, Ben Bernanke.1 Even so, Yellen — the first woman to head the central bank — takes over at a turning point when the Fed has begun to wind down the extraordinary measures instituted during the recession and may need to shift course as the economy continues to recover. This might be a good time to consider the direction the central bank is likely to take under its new leader.
Meet the Chair
Dr. Yellen — who prefers to be called “the chair” rather than chairwoman or chairperson — is a highly regarded economist who has specialized in the causes, implications, and mechanisms of unemployment. She received her Ph.D. in Economics from Yale and taught at Harvard and the University of California at Berkeley, where she remains on the faculty as Professor Emeritus. Yellen joined the Federal Reserve Board of Governors in 1993 but left in 1997 to chair the President’s Council of Economic Advisers through 1999. She returned in 2004 as head of the Federal Reserve Bank of San Francisco before becoming Vice Chair of the Board of Governors in 2010.2
Yellen has a reputation as a clear communicator who can present complex economic issues in plain language. She is considered a “dove” who is inclined to allow a freer flow of funds to stimulate jobs and wages in carrying out the Fed’s dual mandate to foster maximum employment while controlling inflation.3 (By contrast, “hawks” tend to be more concerned about the potential for inflation.)
Under Ben Bernanke, the Federal Open Market Committee — charged with setting monetary policy — began issuing “forward guidance” to provide advance notice to consumers, businesses, and investors regarding future policy direction. In December 2012, with the unemployment rate at 7.8%, the Committee anticipated maintaining a near-zero federal funds rate — its primary tool to stimulate the economy — as long as the unemployment rate remained above 6.5% and inflation expectations were no more than half a percent above the longer-run goal of 2%.4–5
A year later, in December 2013, the unemployment rate had dropped to 7.0% and was on its way to 6.7% by the end of the month.6 Recognizing that unemployment was only one part of the labor picture, the Committee hedged on its previous statement, indicating that it would consider a wider variety of economic factors and expected to maintain the low federal funds rate well past the time that unemployment declines below 6.5%, as long as inflation remains in check.7 This has created an open-ended situation in which Yellen and her colleagues must decide which conditions might trigger raising rates.
With unemployment down to 6.6%, Yellen affirmed this policy shift in her testimony to Congress, citing other labor concerns such as the large numbers of long-term unemployed and the underemployed, and the fact that wages have lagged growth in productivity. In addition, she emphasized that inflation has remained low and is not an impediment to maintaining the near-zero federal funds rate for now.8-9
At the same time, Yellen stated her commitment to the current gradual pace of tapering the Fed’s bond-buying program (known as “quantitative easing”) — which has put downward pressure on longer-term rates — unless there is a “notable change in the outlook.” She also emphasized her commitment to the Fed’s mission as a regulatory authority over the financial industry.10
What Can You Expect?
Yellen’s message offered a welcome shot of confidence for the stock market, which values consistency and seems reconciled to gradual tapering in an improving economy.11 Her stance might also inspire confidence among businesses and consumers who may benefit from low interest rates for expansion, hiring, and purchases.
For retirees and others who might prefer higher rates on savings, however, the prospect of prolonging the low-rate environment could be a concern. Consumers who see prices rising at their local grocery stores may wonder about the talk of “low inflation.” However, aided by lower gas prices, inflation (based on the Fed’s preferred measure) was only 1.1% in 2013.12
It appears for now that the Fed will take a measured approach under Janet Yellen, emphasizing job creation as a stronger policy focus than controlling inflation. However, Yellen also made it clear that the central bank would react as necessary to significant changes in the economy.13
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1, 3, 9–10, 13) NewYorker.com, February 11, 2014 2, 4, 7) Federal Reserve, 2013–2014 5, 6, 8) U.S. Bureau of Labor Statistics, 2014 11) Bloomberg, February 11, 2014 12) U.S. Bureau of Economic Analysis, 2014