“Freedom beckons,” started Lord Mervyn King, former governor of the Bank of England and Professor of Economics and Law at New York University, in what would be a lighthearted conversation on campus with Federal Reserve chairwoman Janet Yellen on November 21. Just one day before the event, which was at capacity, Yellen had announced that she would be leaving the central bank early next year.
If confirmed in the Senate, Jerome Powell will succeed Yellen in February and is expected to stay essentially on the departing Fed Chair’s course. Most consider Yellen’s tenure spectacularly successful, looking back on a period in which unemployment decreased from 6.6 percent to 4.3 and inflation remained consistently under the 2 percent target. In one of her last public appearances, Yellen provided advice on creating a good policy and spoke warmly about her colleagues and mentors.
In her role as chairwoman, Yellen has worked to normalize monetary policy, which, put simply, boils down to maximizing employment and stabilizing prices at a targeted 2 percent inflation. The Fed is faced with a delicate balancing act, as removing policy accommodations too rapidly or too slowly poses inherent risks. If monetary policy moves too quickly, the Fed could precipitate a downturn in the economy, leading the country back into recession. If policy moves too slowly, however, a boom-bust situation could result. Unemployment, already at its lowest in nearly 17 years, could fall even further, triggering a sudden jump in inflation, forcing the Fed to respond with aggressive rate hikes and potentially ending the current economic expansion.
Current policy dictates that the Fed will stop reinvesting proceeds of maturing bonds in new issues, slowly shrinking the bank’s portfolio and increasing long-term interest rates. This path forward will avoid overheating the economy, stabilizing the credit crucial to home mortgages and loans for business investment.
In response to one of the opening questions, Yellen shared three key factors to creating good policy—an open mind, flexibility and careful deliberation. She stressed the importance of questioning old assumptions, since economic factors vary wildly over time. Interestingly, she spoke in similar terms about flexibility—while communicating to the public is serious business, it’s important for the Fed to continuously adapt. Lastly, Yellen highlighted the importance of careful deliberation. She referenced spending more than a year formulating the public presentation of the Fed’s balance-sheet-shrinking plan. When she joined as chairwoman, that balance sheet had jumped from $1 trillion to $4.5 trillion through massive asset purchases.
The Fed, under Yellen’s care, has also made crucial strides towards increased transparency. King noted an old philosophy at central banks to “keep the press out of the bank and keep the bank out of the press.” In defining bank communication objectives, Yellen conveyed that the Fed, as a “powerful, independent institution that controls key economic policy tools in democratic society, has an obligation to communicate to the public and members of Congress to make clear what it’s doing, what its objectives to policy are and its logic.” The clearly delineated goal of independence from the Council of Economic Advisors or the White House was a testament to the Fed’s unbiased nature and to its public service priority. Yellen further recognized the critical press relationship and the manner in which communication affects market behavior. For instance, clearly communicating inflation objectives helps to anchor interest rate expectations around 2 percent, and the Fed can focus policy building more on employment. Yellen gave the example of temporary shocks driven by oil prices; if expectations are well-anchored, the central bank can ignore it in monetary policy. When poorly communicated, though, expectations can drift further downwards, lowering the average interest rate and negating the utility of a key tool used by the Fed to combat economic shocks.
Yellen also discussed in brief the mystery around this year’s low inflation, which has unexpectedly persisted despite a growing economy and strong labor market. Yellen defended the Fed’s plan to gradually increase interest rates over the next few years. Although, according to the Wall Street Journal, the “weak inflation readings could be a sign that interest rates should remain lower than anticipated,” maintaining low rates for too long could cause inflation to grow too quickly and thereby give rise to a new financial bubble.
Yellen’s interpretation of this ‘mystery’ is due to idiosyncratic factors such as falling oil prices and fierce competition between mobile service companies; similar to oil price decline, there was decline in mobile plan prices due to fierce price competition between service companies.
Yellen echoed her earlier comments regarding factors that make a good policy, stating that keeping an open mind and “not a monopoly on truth” has been crucial for the Fed to deal with this issue.
Despite her candid and serious approach to monetary policy, the conversation was upbeat, as Yellen reminisced about her first day on the job three years ago. She described a small swearing-in ceremony, which was followed by a larger public event several weeks later and a video message to her staff. When asked if there was champagne, Yellen laughed, saying, “well, it’s a work day after all, Mervyn. We saved that for a family treat in the evening.”
Speaking of family, Yellen spoke warmly of her husband George Akerlof, a co-author of some of her earlier works, and a supportive partner whose attitude of “absolutely, we’re going to make it work” helped her grow her career in public policy. Although she noted that her husband is the most interesting person she’s ever met, Yellen revealed that the most influential economist has been James Tobin, Yale University economist and leading Keynesian theorist.
Yellen’s passions for economics and her accomplishments at the Fed will make her a sorely missed leader at one of the most influential institutions in the world. However, it is certain that Yellen will continue to stay in economics.
When asked what she did to get away from economics, she answered “now, why would I want to do that?”