The Bank Stops Here

5 minute read

[Yellen will focus on job growth]

When the right person is holding the right job at the right moment, that person’s influence is greatly expanded. That is the position in which Janet Yellen, who is expected to be confirmed as the next chair of the Federal Reserve bank in January, now finds herself. If you believe, as many do, that unemployment is the major economic and social concern of our day, then it is no stretch to think Yellen is the most powerful person in the world right now.

Throughout the 2008 financial crisis and the recession and recovery that followed–a period made more painful by Washington gridlock–central banks have taken on the role of stimulators of last resort, propping up markets and the global economy with vast amounts of money in the form of asset buying. Yellen, previously a Fed vice chair, was one of the principal architects of the Fed’s $3.8 trillion money dump. A star economist known for her groundbreaking work on labor markets–including the contrarian idea that low wages can actually increase unemployment–Yellen was a kind of prophetess early on in the crisis for her warnings about the subprime meltdown and devotion to fortifying the financial system. Now it will be her job to get the Fed and the markets out of the biggest and most unconventional monetary program in history without derailing the fragile recovery. In her November Senate confirmation hearing, Yellen spoke compassionately (and unusually for a Fed official) about the huge strain the past five years have placed not only on income in America but also on families and marriages, especially among the long-term unemployed. “We know that these long spells of unemployment have been particularly painful for such households,” she said.

The good news is that Yellen, 67, is particularly well suited to meet these challenges. Nobel laureate and Columbia economics professor Joseph Stiglitz remembers Yellen, whom he taught at Yale in the late 1960s, as one of his brightest students, someone with a keen understanding of financial markets, an appreciation for their imperfections and a strong belief “that human suffering was more related to unemployment than anything else.”

That gives a key insight into a woman who will have to balance the Fed’s dual mandate of keeping both unemployment and inflation down over the next four years. Some experts, like the pre-eminent Fed historian Allan Meltzer, worry that Yellen will be inclined to “chase unemployment to the detriment of inflation.” But with wages still relatively flat and the economy increasingly divided between the well-off and the long-term unemployed, more people worry about the opposite, deflation that would aggravate the economy’s woes.

Either way, the incoming Fed chief will have to walk a fine line on timing the taper–the plan to slowly wean markets off the stimulus Yellen helped design. It must be steady enough to deflate bubbles and bring markets back down to earth but not so quick that it creates another credit crunch. Yellen’s communication skills will likely help. History shows that exiting from periods of asset buying need not be painful, as long as central bankers effectively and clearly communicate their goals–something Yellen has thus far achieved.

While much of Yellen’s tenure is likely to be dominated by managing tapering, she’ll also have a unique opportunity to shape postcrisis efforts to regulate the financial-services industry and “rebalance the relationship between finance and society,” says Rob Johnson, a financial-reform expert and head of the Institute for New Economic Thinking. While her priority will be making sure that the existing Dodd-Frank banking reforms are properly implemented, she’s already indicated her support for new ideas like cutting the interest rates that banks are paid to park spare cash with the Fed, boosting margin requirements on riskier derivatives trades and requiring big banks to hold more capital. Addressing the too-big-to-fail issue “has to be among the most important goals of the postcrisis period,” Yellen said during her November hearings.

And unlike many past Fed leaders, including Alan Greenspan and, to a lesser extent, Ben Bernanke, she’s not one to buy into the finance industry’s argument that it should be left alone to regulate itself. Princeton professor Alan Blinder, who was the Fed vice chair in the 1990s, remembers speaking many times with Yellen “about how the Fed was being too lax on regulation of finance. And since then,” says Blinder, “it’s only gotten worse.”

That’s an issue Yellen is likely to address–right after she pushes unemployment below 6%, stabilizes markets and makes sure that the recovery is more inclusive and robust. As Blinder says, “she’s smart as a whip, deeply logical, willing to argue but also a good listener. She can persuade without antagonizing.” All those traits will be useful as the global economy’s new power player takes on its most vexing problems.

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