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All eyes on Yellen

by internationalbanker

By John Manning  – john.manning@internationalbanker.com   

The US senate has expressed positive enthusiasm regarding Janet Yellen’s long-term plan focusing on unemployment. However, the challenges she will face in the months and years to come will be critical to her success. Her predecessor, Ben Bernanke, had focused on attempting to keep short-term interest rates low to strengthen and boost the economy, but these measures are unlikely to be enforced by the central bank for much longer. This will see Yellen sailing into uncharted waters.

Yellen strongly backed Bernanke’s plan of quantitative easing, which she is now in charge of. A staggering $75 billion per month is spent on buying bonds, specifically mortgage bonds, to encourage investors to invest, and to persuade people to buy property instead of keeping their money locked away due to a lack of confidence in both the housing market and the banking sector.

The scheme worked to an extent. The Fed gained close to $4 trillion in assets after the ‘08/’09 financial collapse when the stimulus was implemented. With overly optimistic projections for the last two years, the Fed has been forced to keep massive investment figures in place for much longer than they anticipated. The initial drop in monthly investment purchases from $85 billion to $75 billion was initiated in December ’13, but Yellen has to take appropriate actions now to reduce this further. Choosing the correct time and level of ease-in investment is of paramount importance in maintaining the state and progressing the economy.

UntitledYellen testified on Capitol Hill for the first time as Fed chief in February. For over three hours, the spotlight was firmly on her. The House Financial Services Committee scrutinized and challenged her ideas relating to, among other things, quantitative easing and foreign trade policy. Any mistake she made could have resulted in market problems, and would potentially undermine her ability to undertake the role. However, she left the inquisition with enhanced credibility and she offered an insightful way of quantitative easing, stating that, essentially, it buys long-term bonds, which lower long-term interest rates, in turn, boosting interest specific spending, like on property and cars. To be able to put the terms of quantitative easing in terms that even some of the most dried-up Republicans acknowledged as easy to understand is a real credit to Yellen’s communication skills, and her reputation at the Fed has extended to the wider economic world.

Yellen was also direct when talking about the unemployment rate. While it has fallen to 6.5%, she insists that there is more work to be done and cites the ‘slacker’ generation as comprising much of the long-term unemployed ranks. A further concern was the 5% of the population who only work part-time, and the significant shortfall of wages they present in keeping up with productivity growth. Predecessors blamed structural factors for US unemployment levels, but Yellen insists that only a small fraction of unemployment can be attributed to these.

Yellen also pressed home that she believes in the recovery power of the economy. While the Fed predicted a low 3% economy expansion for 2014, and with weak job figures an issue, she remains convinced that there is a way out. Despite disappointing payroll figures for December and January, partially blamed on inclement weather, the Fed is not being forced into panic measures, instead waiting until March when there will be a broader range of data available.

Yellen also insisted focus on industry bubbles that may burst, the credit market in particular. However, she was adamant that there were no immediate concerns. Moderate credit growth, the stock market, and leverage ratios were all discussed as being within bounds, and there were no areas of particular concern for the time being.  However, she did express concern with imbalance in inequality in US wages, and she intends to pay special attention to the growing income polarization. There are claims that the growing inequality is affecting economic growth, but she has refused to be drawn on this, rather stating that the evidence in inconclusive.

Yellen has laid out her plans from day one, and the comments she has given have provided encouragement to both political and economy commentators. It has been a long time since a Fed chair has declared the unemployment is too high and that inflation is too low. She maintains that, since the economic crisis, and the subsequent recession, they have made significant progress restoring the economy’s health to a point that will strengthen the entire financial system. She is a historic figure in terms of what the stands to achieve.

Much has been made of the fact that Yellen is the first ever woman to hold the role of Fed chair, which is, perhaps, the second most important job in the US behind the role of President. While it is culturally significant that there is a female Fed chair and a black President simultaneously, it is not important when considering their on-the-job abilities. Globally, economic experts all agree that Yellen is the best and most qualified person to fill the role.

With the average retirement age of American women currently at 61, it seems Yellen, at age 67, is just getting started. After a three-year stint as Bernanke’s vice-chair, she now holds what is arguably the most high profile post in the economic world. Nevertheless, how much do we know about Janet Yellen? Moreover, what credentials does she have that will give us insight into how she can offer respite to the US economy?

James Tobin was Yellen’s mentor, while she studied for her doctorate at Yale, and his taxation insights earnied him a Nobel Prize. By 1971, her doctorate complete, she became an Assistant Professor at Harvard where she taught one of her rivals for the role of chair, Larry Summers.

Yellen took her first job at the Fed in 1977, and she met her husband George Akerlof, a well-respected economist of the time. After they were married, they both resigned from their Fed roles in order to teach at the London School of Economics, where they made a big impact on both students and colleagues, many of whom cited Akerlof as a genius and a visionary in his economic approach. In the early ‘80s, they returned to the US and took academic roles in San Francisco, where they carried out further research into a vast range of economic factors.

The Federal Reserve appointed Yellen to the Board of Governors in 1994, when she started to forge her own identity and career path. She remained on the board until 1997, when Bill Clinton appointed her as chair of his Council of Economic Advisors.

A decade ago, Yellen became head of the San Francisco branch of the Central Bank, which gave her more exposure to the decision –making mechanics within the Fed. As far back as 2005, meeting minutes show that she was expressing concern about the property market bubble. Even though there were many others that shared the same view, there was no way she could have predicted the events of 2007 when the bubble burst.

The Federal Open Markets Committee saw Yellen become a voting member of the committee in charge of setting interest rates in 2009, and by 2010 she was regarded as a well-respected ambassador for the work of the Fed, who sent her across the globe as their representative for US economic policy. After Donald Kohn left the Fed to join the Bank of England, she was appointed to the vice-chair of the Fed, and she was installed as the new head of the US Federal Reserve on January 6th, 2014, but it was not a landslide victory. Senators voted in favour, 56 for and 26 opposed.

Many economist had previously called for a Fed chair who would show concern about both inflation and growing unemployment rates and who would ensure that jobs and living standards were held of equal importance. Although the Central Bank has a legal obligation to attempt to achieve price stability and low unemployment rates, Yellen has also committed to keep the federal funds rate at 0%, even after the unemployment rate falls beneath 6%. Inflation has fallen below the Fed’s target, which, Yellen argues, will allow the Fed to make further strides in job creation and employment growth. It also seems that there is little concern about for potential rises in the Consumer Price Index, although inflation economists are unlikely to be pleased with the news.

Yellen is a precise problem-solver and through with explanations. Her academic background enables effective data analysis and she is able to explain things in a way that most can understand. She explained that if weak economic conditions continue, and if doubt remains about the 3% growth prediction for 2013, she might slow down the quantitative easing tapering process or stop it entirely. Her flexibility is keen and an important aspect of her policy-making. Current policies, like quantitative easing, will be kept in place, and Yellen stated that the Fed’s course was not pre-set. A re-emphasis of a statement by Bernanke, her stance shows that evolution, not revolution, was key. This sensibility is unlikely to change during Yellen’s tenure. The Fed is seeking a fast return to normality, while also maintaining stability, and this will be Yellen’s challenge during the first six months as chair.

If currents economic and unemployment rates are maintained, it is likely that the Fed will follow through with their plans to slow down the tapering of quantitative easing, but it will take six months, during which time interest rates will rise, and there is a very real prospect of global interest rate rises. All these factors will contribute to the continuation of current market unrest. Turkey’s recent increase on borrowing is a trend that is likely to be followed by many other countries in 2014.

While serving as Bernanke’s vice-chair, Yellen backed Bernanke on every decision. Many commentators expected and predicted that, based on the new chair’s remarks before the House, Janet Yellen will be just like Ben Bernanke. It is not true. In fact, it is not possible. The further we travel towards recovery, the more differences between the economists we are likely to see.

While Bernanke was cyclical in his outlook and methods, Yellen takes a structural approach. She is, after all, a Democrat, and Democrats like efficiency, believing that economic system supplementation is inefficient and that the government should intervene when required. Bernanke was responsible for all the innovative policies during his tenure as Fed chair, and many of them have not been dismissed as they are considered irrelevant to the current economic state. Although he was a man who liked firm rules, many of the rules and metrics he put in place are nothing short of irrelevant and contradictory rhetoric, and his legacy is one of long-term inflation. His metric for unemployment must be measured against the Fed being forced to consult on policy every time there is a significant drop in unemployment.

Now that Yellen is chair, there are no rules, no guidelines, and no metrics. Despite the idea of long-run inflation, what will drive new policy is yet to be discovered. It cannot be known if she agrees with many of Bernanke’s policies, but current information suggests that she does. We are, however, currently at a T-junction in our journey to recovery, and while Bernanke would go one way, it would be no real surprise to see Yellen go the other. While much traditionalist rhetoric remained in her opening speech, there is the sense that she is the ‘real deal’ and economic decisions could be set to improve. She has the experience, and the right supporting cast, to give her the best chance of changing things for the better. It is a role that her life has conditioned her for, however, it is a results-driven industry, and the success of her tenure will only be measured when she is replaced. One thing is certain: continuity of policy can be a shambolic venture and is unlikely to be entertained by Yellen.

To many of us, Yellen’s direction seems clear, and her time frame, obvious. Whether she would agree or not is a matter for debate, but she will certainly have a significant impact, one way or another.


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