Yellen's Fed: Doves and hawks switching feathers
A couple of weeks ago I mentioned in this column the new tool of optimal control that Janet Yellen could use to implement monetary policy. But what will the characteristics of her monetary policy be compared with her predecessor Ben Bernanke’s?
The woman who just assumed the helm of the US Federal Reserve has spent more than 14 years of her life in its service: 1978 as a Fed economist, three years in the mid-1990s as a member of its Board of Governors, six years (2004–2010) as president of the San Francisco Fed and the past four years as Fed vice-chair. In her tenure she has gained the reputation of a “dove,” i.e. she tends to favor the goal of full employment over that of containing inflation in the Fed’s dual mandate.
While this reputation might be justified, Yellen has always endorsed Fed decisions, even when the central bank adopted a more restrictive stance. In addition, although a Democrat, she has uniformly favored a responsible fiscal policy and balanced public finances. This is a far cry from the caricature of a hyper-Keynesian some conservative pundits accuse her of being. Moreover, there are three other reasons why the Yellen Fed may be more restrictive than what we grew accustomed to under Bernanke.
First, the Fed chair doesn’t decide monetary policy alone. This decision is taken within the Federal Open Market Committee (FOMC), which consists of 12 members: the Fed chair, the vice-chair, the five permanent members, the president of the New York Fed (FOMC vice-chair), and four other presidents (or governors) of the other regional Federal Reserve banks (there are a dozen in all). The latter positions rotate yearly. And in 2014, two “doves” – the governors of the Boston and Chicago Feds – have been replaced by two “hawks,” the governors of the Federal Reserves of Philadelphia and Dallas.
The president of the Philly Fed, Charles Plosser, is especially worth mentioning. He is a former professor of macroeconomics and a founding father of the Real Business Cycle Theory, which argues that business cycles are the optimal response of an economy to exogenous productivity shocks. Fiscal or monetary interventions to smoothen these cycles are at best useless and at worst counter-productive, this theory posits. That an economist with such a background is part of the Fed decision-making process is akin to an atheist philosopher becoming a cardinal in the Roman Curia.
Second, the role of the Fed chair is fundamentally different from that of the other FOMC members. Indeed, in addition to having an opinion, the Fed chair seeks above all to rally colleagues to a decision and is therefore quick to compromise to build consensus. It would be disruptive, especially at the outset of a new Fed chair’s term, to create large divisions within the FOMC. Yellen will therefore presumably move from dove to pragmatic centrist.
Third, on January 10, Stanley Fischer was nominated Fed vice-chair. As a one-time economics professor at MIT, the thesis supervisor for both Bernanke and European Central Bank head Mario Draghi, as well as a former World Bank chief economist, vice-president of the International Monetary Fund, and governor (2005–2013) of the Central Bank of Israel, he is a living legend among macroeconomists and central bankers alike. Although we do not know how he will lean within the Fed, the fact that he successfully battled inflation in Israel and has recently expressed doubts about the new Fed policy of forward guidance, at least in its calendar-based conception, could place him within the camp of pragmatic hawks instead of the company of the doves.
So, at least at the beginning of Janet Yellen’s mandate, I do not expect a profound change in the Fed’s monetary policy – at most a slight shift. But if such a shift occurs it will paradoxically change the Fed from a dove in hawk’s feathers to a hawk in dove’s feathers.