Why has there been so much chatter and debate over who should be the next person in charge of the Federal Reserve? Because of the Fed’s significantly increased importance in recent years. The head of the Fed has been called the second-most important person in the US and even the world, and sometimes #1.Janet Yellen, nominated to be the next Fed head and first chairwoman ever effective Feb. 1, 2014, is likely to be confirmed by the Senate because she has broad support among the Democratic majority. Still, the process might be contentious, given the current partisan battle over funding the federal government and raising the debt limit.
Yellen, currently the Fed’s vice chairwoman, has much more experience as a central banker than current chairman Ben Bernanke, his predecessor Alan Greenspan and indeed any of the other 12 men before they became Fed chairmen.
She also has the best track record among current Fed members, according to a Wall Street Journal examination of some 700 predictions on growth, jobs and inflation by 14 Fed policymakers between 2009 and 2012 in speeches and congressional testimony. And she was one of the few Fed members who warned in 2007 that recession could be around the corner.
Whatever the benefits of quantitative easing have been, Yellen correctly predicted that it wouldn’t lead to soaring inflation and a tumbling dollar. Though the Fed has printed a huge amount of money, risk-averse banks aren’t lending much and debt-constrained consumers aren’t borrowing much.
Greenspan, who was chairman from 1987 to 2006, was notorious for his deliberately confusing pronouncements. Bernanke has been much more open and direct. Yellen wants to go even further in clearly telegraphing the Fed’s intentions to the financial markets. She wants the Fed to be more systematic, predictable and transparent. She is often referred to as “methodical̶! 1; and committed to stricter, clearer guidelines.
The new Fed chairman is largely expected to continue the Bernanke Fed’s policies. However, she is viewed as even more dovish, or less concerned about inflation, than he. In addition, she has expressed greater concern about the economic consequences of unemployment, and the view that the Fed should do more to stimulate job growth.
At the White House on Wednesday, for example, she said, “More needs to be done to strengthen the recovery. Too many Americans still can’t find a job and worry how they’ll pay their bills and provide for their family.”
In the aftermath of the financial panic of 1907, the Fed was established in 1913 to provide emergency loans to banks during economic crises. Its role and authority have since grown considerably. A 1977 law gave the Fed a “dual mandate” of maximum employment and stable prices. The Fed’s power to regulate banks also has expanded significantly.
In addition to continuing or adapting approaches in which she has already been actively involved, Yellen will also need to return monetary policy from its aggressive, financial-crisis extreme to something more “normal.”
Basically, that probably means a gradual tapering of the Fed’s $85 billion monthly purchases of Treasury and mortgage securities (dubbed quantitative easing). Since 2006, the Fed’s securities holdings have expanded from $750 billion to $3.8 trillion.
A key is to do this without slowing down the economy. Yellen likely will demand more concrete evidence, particularly from employment and housing statistics, that the recovery isn’t faltering.
Another key is to convince investors that starting to taper absolutely doesn’t mean the Fed will raise the short-term interest rates it controls any time soon. Bond yields climbed sharply after Bernanke first broached the topic of tapering in May. Evidently the markets aren’t yet convinced t! hat taper! ing and raising rates aren’t linked.
All the evidence strongly indicates that the Fed expects to keep short rates in their current zero-0.25 percent range for quite a while, such as another two years or more. As long as the overnight Fed funds rate stays so low, yields of longer-term issues likely can rise only so high.
The other 18 policymakers will also have a say. Managing their diverse opinions and their willingness to voice them publicly has become increasingly challenging.
One can debate the effectiveness of recent years’ Fed policy in stimulating economic growth and reducing unemployment. However, that effort has been impeded by the lack of fiscal stimulus, such as increased government spending and reduced taxes, that typically fuels an economic recovery.
For better or worse, the Fed has tried to fill a vacuum left by Washington’s political dysfunction.
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