Despite the fact that at the time of writing Janet Yellen still needs the full U.S. Senate to confirm her nomination as Federal Reserve chairman, there is little doubt that come Feb. 1, 2014, she will be the 15th person and the first woman to lead the Fed in its almost 100-year history. (Late last month shw won approval from the Senate Banking Committee).
From the moment President Barack Obama nominated Yellen for the esteemed chairman role. it became widely believed that all contemplated Fed policy changes were immediately put on hold. It should not have come as a surprise that tapering was taken off the table at the last Federal Open Market Committee meeting, and one should not expect any changes in monetary policy during this sensitive transition in leadership.
Given the major role the Fed plays in the global economy today, understanding the new leader is critical. Based on this premise, it is worthwhile examining the differences between current Fed chairman Ben Bernanke and his likely successor. Both Yellen and Bernanke are beneficiaries of a tertiary education at a highly regarded institutions (Bernanke: MIT, Harvard; Yellin: Brown and Yale universities), pursued PhD’s in economics and started their careers as economics professors. Furthermore, their research and work history has earned them a great degree of credibility and has made them two of the most distinguished economists in the world.
In terms of economic research and views, Bernanke is most well-known for his assessments and research on deflation. In his first speech as chairman of the Board of Governors of the Federal Reserve, he proclaimed that the Fed not only had the responsibility to prevent inflation, but also deflation. He prescribed specific measures that the Fed can use to prevent deflation, which is now referred to as the Bernanke Doctrine.
Yellen’s body of research, on the other hand, is focused on unemployment and labor markets. Her most cited paper – co-authored with her husband, Nobel-winning economist George Akerlof, is “The Fair Wage-Effort Hypothesis and Unemployment.” According to Yellen, labor markets are not able to create full employment without the implementation of expansionary policies.
Although their research focused on different areas Bernanke and Yellen are both believers in the Keynesian school of economic thought. Developed by British economist John Maynard Keynes, Keynesian economics argues that capital economies are not self-regulating, therefore advocating government intervention in the economy to help support functioning markets. According to Keynes, during times of recession, government should pump money into the economy, creating a soft landing and providing the support needed for the economy to grow on its own.
Yellen, like Bernanke, is of the view that unemployment is a greater hazard to the economy than inflation. She previously commented that reducing unemployment should take center stage even if this might result in inflation slightly and temporarily exceeding 2 percent.
The Brooklyn native has been described by some as one of the most dovish members of the policy setting agency. Yellen has clearly communicated her intent to continue with the accommodative policies her predecessor initiated, but that should not be confused with being extremely dovish. While she believes that curtailing unemployment should be a priority, any hint of possible hyperinflation would immediately change her focus to controlling inflation. Having lived through stagflation in the ‘70s, with unemployment and inflation increasing at the same time, Yellen is painfully aware of the consequences of a slow response to rising inflation expectations.
With Yellen at the helm of the U.S. central bank, we should expect a continuation of current Fed policy – interest rates near zero as long as unemployment remains above 6.5 percent and inflation tempered. It is also clear that tapering the purchases of $85 billion a month of mortgage and treasury securities is the next action the Fed will take. Recent committee minutes indicate that the greatest challenge is how to effectively communicate this to prevent misinterpretation by the market and a subsequent rise in mortgage rates. One idea discussed at the last FOMC meeting was the purchase of short-term Treasury securities as a tool to keep short-term interest rates anchored, even if the Fed starts reducing QE3.
Yellen is a proponent of transparency and will endeavor to keep market participants informed through forward guidance. According to Nobel prize winner James Tobin, Yellen, who was a graduate student in his class at Yale university, has a genius for expressing complicated arguments simply and clearly. Only time will tell if her synthesizing skills will see her through the challenges she will face as one of the most powerful people in the United States next to the president. In the meantime, however, Yellen is synonymous with a continuation of an accommodative Fed, which is favourable for equity markets.
Disclaimer: The views expressed are the opinions of the writer and while believed reliable may differ from the views of Butterfield Bank (Cayman) Ltd. The bank accepts no liability for errors or actions taken on the basis of this information.