A diminutive woman with a pixie haircut is deciding the future of the world’s biggest economy, and we don’t know what she’s really thinking.
It’s not that Janet Yellen is mysterious by nature. She’s a regular person from Brooklyn. She has an open face and a warm smile and, as her predecessor Ben Bernanke told me recently, “more of the common touch than I did.” She also has a decade-long pedigree serving in various jobs at the U.S. Federal Reserve. (“If you were dreaming up a training school for Fed chairmen, it would be her life story,” her old colleague, Alan Blinder, once joked.) Yet there are so many unknowns about where Yellen is taking the newly empowered Fed that she’s making Alan Greenspan look plain-spoken by comparison. Seven months into her tenure, her favorite locution so far appears to be some form of “we don’t know.”
I’m not just talking about Yellen’s something-for-everybody speech Friday at the annual Jackson Hole meeting for central bankers – when she said that the labor market has “yet to fully recover” (pleasing inflation “doves”), but that neither do we know how imminent inflation is (assuaging hawks). She is also being cagey about how much she intends to fulfill the Fed’s broad new role as stern overseer of the U.S. economy—and master of Wall Street.
As has been written, Yellen is clearly passionate about the employment problem. It was no accident that the theme of this year’s Jackson Hole meeting was “labor market dynamics,” and the AFL-CIO’s chief economist, Bill Spriggs, was invited while Wall Street economists were not. (“The Fed organizers wanted to keep the focus on labor,” Spriggs told me. “Their fear was the Wall Street economists would just want to get into the minutiae of Fed policy.”) But she won’t say precisely how she’s measuring unemployment. Bernanke’s Fed had used a 6.5 percent unemployment rate threshold for guidance on when to begin worrying about inflation. When the rate dropped to that level, Yellen came up with an important innovation: Rather than simply setting a new metric, she announced that the Fed would now assess the labor market more qualitatively, roaming across a range of no fewer than 19 different indicators under a “Labor Market Conditions Index.”
All of which only gave her even more latitude to say, “We don’t know.”
Some accounts have painted Yellen as a full-throated progressive –a pro-labor throwback to the pull-out-all-the-stops Keynesians of the pre-Reagan era—but her main sponsor for the Fed job, Bernanke, disagrees. “I think that, philosophically, Janet is very much within contemporary mainstream economics. She is appropriately concerned about jobs, as I was, but she has also shown that she is committed to maintaining price stability,” the former Fed chief, now at Brookings, said in an interview this month.
But Yellen is overturning the traditional ways of looking at the labor markets, talking of pragmatic responses and dispensing with traditional macroeconomic formulas. Using her new index, she is disaggregating the unemployment rate in ways Fed chiefs haven’t done before, and she’s become as much a psychologist as a numbers person—wondering openly whether all those despairing dropouts and part-timers can be lured back into the workforce. Yellen is also very cagey about whether that’s happening or not: She’s playing her own private game of chicken with inflation, indicating that she wants to see more wage growth for workers (another thing that’s hard to track ahead of time) before she raises rates. Beneath the careful analysis and the caveat-freighted sentences, the bottom line seems to be: “We’re making this up as we go along.”
Another big change in the Yellen era is that for most of Bernanke's tenure, the Fed played a regulatory role in banking, but possessed no statutory responsibility to oversee the systemic stability of the entire economy. Now it does. There’s much greater sense, not just from the changes under the Dodd-Frank law but also in the Fed’s internal thinking, that the Federal Reserve’s biggest job of all in some ways is this one: to monitor overall stability. It has greatly increased resources for doing that, and Yellen has called for even more “macro-prudential”—the voguish term that means the Fed’s new task is to watch the behavior of the nation's financial sector, especially Wall Street, very closely—tools that respond to specific threats, like the way British regulators put new restrictions on mortgage lending. Earlier this month, the Fed and Federal Deposit Insurance Corp. rejected the banks’ “living wills”—in other words, their plans for an orderly bankruptcy if they get into trouble –as unrealistic. That’s basically the Fed’s way of saying the banks still have a lot of restructuring to do to make themselves more stable, or else the Fed and FDIC can decide to dismember them.
In this way too there is a quiet and little-understood revolution going on beneath our noses—Yellen called it a “work in progress” at Jackson Hole—and the only question is how aggressively she’ll wield her new power. Again, we just can’t say. Remember back in the Greenspan era, when all the talk was of asset bubbles and whether or not the Fed should burst them by jacking up rates? No one then saw the financial system itself as a source of risk. Now, post-crisis, Yellen is turning all that around, saying that getting macro-prudential policy right should by itself take care of fretting about most asset bubbles: If finance is tightly leashed, then asset bubbles can’t do that much damage to the economy. Yellen is saying, in other words, that she intends to resurrect the lost art of regulation with a vengeance—and during the Greenspan era of bank self-determination, regulation truly did become a relic—and that in turn should change the way we think about monetary policy, too.