Judgment reserved on Fed first lady Janet Yellen

Janet Yellen has been a strong supporter of QE during her three years as vice-chair. Picture: Getty

WHEN she appeared before the US Senate banking panel in November, Janet Yellen knew she was not only taking another step towards one of the most powerful jobs in world economics, she was also about to enter the history books. She takes over at the end of this week as chairman of the Federal Reserve, the first woman to hold the post, but the confirmation hearing attracted comment beyond being a test of her credentials as an economist.

The 67-year-old was dressed in the same black suit she wore a month earlier when President Barack Obama announced her nomination, enough for her to be targeted by bloggers Warren Rojas of Roll Call and Patrick Tutwiler of FishbowlDC.

“Good thing the Fed Chairman is only the most powerful position in the world, and not a walk down the red carpet,” Tutwiler wrote. “Otherwise we’d be worried.”

Rojas said it had yet to be seen whether Yellen was the “financial genius our sputtering economy so desperately needs”, but “at least we know her mind won’t be preoccupied with haute couture”.

Their rather sneering comments predictably stoked a backlash of outrage. Other commentators pointed out that all three of Yellen’s immediate predecessors – Ben Bernanke, Alan Greenspan and Paul Volcker – frequently wore the same suit in public more than once without attracting attention.

On a more subtle level, some have questioned whether the lady is tough enough to run the Fed – particularly one where opinions are diverging on the next stage of economic recovery.

Her predecessor leaves after six years of crisis control and damage limitation that has included several rounds of quantitative easing (QE), a controversial programme that Bernanke credits with saving the economy.

His efforts have added almost $4 trillion (£2.4tr) to reserves in the US banking system, five times the balance sheet accumulated in the 92 years before Bernanke arrived. Critics claim this is laying the foundations for another market bubble and could trigger severe inflation, though so far the latter remains under control.

Yellen has been a strong supporter of QE during her three years as vice-chair under Bernanke, and also spearheaded the central bank’s adoption of a 2 per cent inflation target.

But she is a so-called dove – willing to tolerate slightly higher prices in order to address unemployment. The upward pressure that low interest rates put on inflation is of less concern than keeping down the cost of borrowing as a way of spurring investment and creating jobs.

Many conservatives are hawks on inflation, and argue that the main concern should be keeping prices under control. Officially, the Fed has a dual mandate to maintain price stability while also maximising employment, something Democrat Yellen says can be done.

“The mandate of the Federal Reserve is to serve all the American people,” she said on the day of her nomination. “And too many Americans still can’t find a job and worry how they’ll pay their bills and provide for their families.

“The Federal Reserve can help if it does its job effectively. We can help ensure that everyone has the opportunity to work hard and build a better life. We can ensure that inflation remains in check and doesn’t undermine the benefits of a growing economy.”

Despite such assurances, conservative group American Principles in Action launched an online campaign and website, NoOnYellen.com, to oppose her appointment. Its video included comments from three Yellen critics, including the group’s chairman, Sean Fieler, who is president of New York hedge fund Equinox Partners.

“Janet Yellen is an enormously well-credentialed economist who also happens to be an inflationist who should not be allowed to run the Federal Reserve,” Fieler says in the video.

James Grant, founder of Grant’s Interest Rate Observer, says Yellen is energetic and dynamic but “would do enormous damage” as Fed chair.

Yellen faced tough questioning during her confirmation, but she always looked odds-on to gain approval. She passed easily at the start of this month with a vote of 56 to 26, though this was still the thinnest margin of Senate approval for a Fed chairman in the central bank’s history.

She now faces the arduous task of gradually unwinding the extraordinary measures the Fed has adopted to revive the economy. Trouble is, there is little consensus on how this should be done.

Last month, Yellen joined Bernanke and nine others on the committee in a vote to begin curtailing – or “tapering”, in market lingo – the QE bond-buying programme.

QE3, the third incarnation of quantitative easing in the US, began in September 2012 and has involved the monthly purchase by the Fed of $45 billion (£27.2bn) of Treasury bonds, plus $40bn of mortgage-backed securities. The newly minted cash created by the Fed to pay for these assets is meant to go back into the wider US economy, but many investors have opted to play markets abroad.

Bernanke has said the committee will continue cutting by $10bn a month until QE comes to an end, a timescale that has led Wall Street to believe that the liquidity injections will finish up when this year draws to a close. But minutes of the December meeting released this month reflect far less certainty than the outgoing chairman might like to project and there seems a strong tendency to keep most if not all options open.

“Among those inclined to begin to reduce the pace of asset purchases at this meeting, many favoured a modest initial reduction accompanied by guidance indicating that decisions regarding future reductions would depend on economic and financial developments as well as the efficacy and costs of purchases,” the minutes note.

They go on to stress that members felt any future cuts should be contingent upon the committee’s outlook for the labour market, as well as inflation prospects.

This will be a focal point for Yellen. As an ardent proponent of monetary policy that benefits Main Street, labour market data is central to her thinking.

Latest jobless figures suggest that US unemployment has fallen to 6.7 per cent, but this is flattered by a growing number of people who have been out of work for so long that they have given up on looking for a job. Experts estimate that if these “discouraged workers” rejoined the hunt, unemployment would shoot back up to 7.7 per cent.

Yellen is aware of the situation. “About 36 per cent of those unemployed have been unemployed for more than six months,” she said in an interview in June.

“This is a very unprecedented situation. We know that those long spells of unemployment are particularly painful for households, impose great hardships and costs on those without work, on the marriages of those who suffer these long unemployment spells and on their families.”

Such statements have prompted speculation that she might be an even stronger proponent of extraordinary policies than Bernanke. It also points to a continuation of low interest rates, which have sat at 0.25 per cent since the onset of the crisis. But whichever way she’s inclined to move, she will face opposition. At least two top executives from the Federal Open Markets Committee – the 12 regional Federal Reserve Banks in major cities throughout the US – have become increasingly vocal in their growing discomfort about the benefits of QE. Yellen may deem at some point that tapering needs reversed, but she will be constrained by a lack of consensus.

On the other hand, the head of the Minneapolis Fed has called for more economic stimulus. Narayana Kocherlakota is concerned by an “inappropriate” complacency that inflation – currently at 1.5 per cent – will consistently run below the 2 per cent target. His comments reflect an increasing concern that low global growth could give way to deflation – a destabilising condition in which falling prices freeze economic activity.

Kocherlakota wants the Fed to be clearer about what it will do when official unemployment falls below the threshold of 6.5 per cent while inflation at the same time is stuck below target.

That gauntlet rests at the feet of Yellen, who has championed the forward guidance the Fed has used to shape expectations and keep markets calm. The coming months will not only be dictated by the various balancing acts she must perform, but also her ability to explain the reasons for each delicate step.