Janet Yellen, who assumes control of the Fed come 1 February (and prefers to be known as Janet Yellen, Chair of the Federal Reserve), appears to be cut from the same cloth as her predecessor Ben Bernanke. Make no mistake, she is a Fed insider, having served as Vice Chair since 2010, and since 1994 she has intermittently been part of the Federal Reserve System. Moreover, it’s safe to assume that she’s had her hand on the throttle since she was announced as a replacement to Bernanke in September. So, reading the tea leaves going forward, what can we expect from Chair Yellen?
Yellen faces a staggering balance sheet of $4 trillion that’s still growing, thanks to the excesses of Quantitative Easing (QE), despite the taper from $85 billion to $75 billion of the Fed’s monthly asset purchase program. In the meantime, the Fed is keeping its federal funds target rate at close to zero — which it has done so since the end of 2008 — in its efforts to manipulate the money supply in the U.S. economy. While 2013’s “official” rate of inflation has been estimated at 1.5% (according to data released by the federal government on 16 January 2014), when applying official government CPI metrics used in 1990 it’s closer to 5%.
As Deutsche Bank U.S. chief economist Joe LaVorgna explains, “Either there’s going to be a major accident on the path to normalization and/or there’s going to be a financial asset bubble or inflation somewhere down the line. Something has to break.” Instead of reconstructing the U.S. economy for the benefit of working class Americans, the Fed’s QE has thrown trillions at Wall Street and banks with very little to show in terms of employment.
In an interview with ‘Time’ magazine, Yellen disputes the idea that asset buying “is just helping rich people. It’s just not true,” she said, explaining that the policy “is aimed at holding down long-term interest rates (to) support the recovery by encouraging spending.” Yellen is infatuated with the idea that the Fed can “optimally control” the U.S. economy by using a macroeconomic model based on optimal control mathematics. In her world, the Fed suppresses the funds rate as unemployment falls faster until our country reaches “full employment.” Thus, expect interest rates to remain at basement levels for the foreseeable future while the real rate of inflation, currently at around 5%, continues to drain Americans’ wealth.
There appears to be a policy conflict between Yellen and the Fed’s Open Markets Committee, which voted for a tapering sooner than markets had expected. The new Fed Chair apparently believes that she can massage QE rates to lead the future expectations of financial markets. She remains unconvinced of the economic recovery, so if indicators worsen later this year she may actually open the spigots wider and expand QE further.
One can look to this past October when Yellen was nominated by President Obama for indications of where she wanted to take the Fed. Both Bernanke and Yellen considered the pace of payroll growth too anemic to begin withdrawing stimulus. Fast forward to January 28 and 29, when multiple reports claim that the Fed will taper QE even further, from $75 to $65 billion despite the disappointing jobs report in December. What changed between October and today? With presumably a straight face, in mid-January Chicago Fed President Charles Evans said in a speech that “the labor market has improved.” As long as markets such as the DJIA continue trading at near all-time highs, the Fed apparently believes that they can taper QE without spooking investors. If the U.S. economy remains in the doldrums and economic growth misses the rosy revised projections of the IMF for 2014, look for Yellen to ramp QE back up to former levels.
According to Michael Hirsh in the ‘National Journal,’ Yellen is “the product of an old progressive tradition of activist, pro-government economics.” This characterization is not dissimilar to that of Bernanke, who has been described as a scholar of the Great Depression and one determined to keep America from going through another in the 21st century. As a proponent of government intervention in markets, she will use her embrace of behavioral economics to address unemployment while deprioritizing inflation. As Hirsh asks, will Yellen “try to out-Bernanke even Bernanke”?
Fed analyst and author David Jones believes that Yellen’s “biggest challenge now is to reverse the Fed’s highly accommodative policy,” but one that runs counter to her instincts on how to tackle unemployment and income inequality. As LaVorgna says, “We haven’t felt the full effects of the accommodation.” What’s more, the accommodation may not yet be over.
Perhaps the best description of Yellen is that of a “old-style hydraulic Keynesian'” who, with her faith in behavioral economics, believes she can keep the train (the economy) “on the tracks,” conjuring money from thin air to stimulate employment. If, as LaVorgna maintains, a financial crisis awaits the U.S. economy — either from hyperinflation or a economic bubble burst — or if America suffers Japan’s fate of an aging population with persistently feeble growth and subterranean interest rates, Yellen’s monetary activism may be incapable of reviving the U.S. economy.