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Friday, March 12, 2010

Is Janet Yellen Really a Dove?

Larry Meyer on Janet Yellen's nomination as Vice Chair of the Federal Reserve Board:

Meyer on Yellen as Fed Vice Chair: "The best possible choice", by Larry Meyer, MacroAdvisors: President Obama is reported to soon announce his decision to nominate Janet Yellen as Vice Chair of the Federal Reserve Board... My reaction to the President's choice: an enthusiastic Hurray! ... I am biased. Janet is one of my favorite people, a good friend, a former colleague (both at the Board and briefly at Macroeconomic Advisers) ... I want to say a few ... words about ... how her appointment could affect monetary policy decisions. ...
Many in the markets ... will be interested in only one question: How will the nomination affect monetary policy decisions, specifically the timing of exit from the current near-zero rate? Janet Yellen is today, certainly, among the doves on the Committee. I will be posting a commentary soon ... where I explain what makes one a hawk or a dove ... and whether it matters. The conclusion is that it does not matter... The reason is, as said to me by a member of the Board: "The Chairman owns the room." When the Chairman wants to move away from the near-zero funds rate, the Committee will do so. Until that time, he will always enter the room with at least eight votes in his pocket and with assurance that there will be several more each time. As Vice Chair, Janet can never vote against the Chairman. She can never take a substantially different view than the Chairman around the table. This is the etiquette of being a Vice Chair... It goes with the territory. You don't take this position if you cannot abide by this rule. Fortunately, this won't be a problem for Janet. First, she holds views that are not very different than the Chairman's. Second, she has utmost confidence in his judgment, and the feeling is mutual. She will, almost alone on the FOMC, continue to have the opportunity to help shape that judgment. Janet surely appreciates ... that the only way she can affect the policy decision is to convince the Chairman to alter his recommendation to the Committee is to reach him before the meeting. What we can say for sure is that Janet will surely help the Chairman make the best decision, even in those occasions when he ends up disagreeing with her.
The final question is whether Janet is really a dove. Let me tell you a story. Janet and I held very similar views when we were colleagues on the Committee, despite the fact that I was immediately viewed as a hawk and she was already viewed as a dove. (I thought of myself at the time as being a "hawkish dove.") In any case, when it comes to ensuring price stability and maintaining well-anchored inflation expectations, there are no doves on the Committee. Before the September 1996 FOMC meeting, Janet and I went to see the Chairman to talk about the policy decision at that meeting and at following meetings. This was the only time I ever visited the Chairman (at my initiative) to talk about monetary policy, before or after a meeting. Janet and I were both worried about inflation, even though it was very well contained at the time. We told the Chairman that we loved him but could not remain at his side much longer if he continued, as he had been doing for some time, to push the next tightening action into the next meeting, and then not follow through. He listened, more or less patiently. I recall, though this may have not been the case, that he just smiled and didn't say a word. After an awkward silence, we said our good-byes. Needless to say, we didn't win this argument. Yet, we never dissented. That is another matter of etiquette for the entire Board, at least since when I was there: The Board is a team, always votes as a block, and, therefore, always supports the Chairman.
Yes, Janet is a dove today. But this is so principally because she passionately believes in the dual mandate (price stability and full employment). ... Given the Fed's mandate, and because she expects the unemployment rate to be very elevated for a long time and inflation to be very low for quite some time, she wants to make a "late" exit from the near-zero rate policy. How could you not be a dove under these circumstances? Certainly I would be a dove if I were on the Committee today. But Janet would quickly switch camps, unquestionably along with all her dove colleagues, if the outlook or her forecast changed such that a serious threat to price stability emerged. There simply are no doves at central banks under these circumstances, and certainly not on the FOMC.

In any case, the minute she was nominated to the Committee she became a centrist. Now, more than ever, she will be side-to-side with the Chairman, who, by definition, is always the center of the Committee. ...

Update: On another topic, in September 2005 post, she was not a fan of Fed intervention to pop bubbles:

Presentation to the members of Parliament at the Conference on US Monetary Policy, by Janet L. Yellen, President, FRBSF: ... I want to focus my remarks today on another longer-term issue, namely, the housing market ... The question is: ...Is there a house-price "bubble" that might collapse, and if so, what would that mean for the U.S. economy? To answer this question, let me begin by clarifying what I mean by the term "bubble." A bubble does not just mean that prices are rising rapidly—it's more complicated than that. Instead, a bubble means that the price of an asset—in this case, housing—is significantly higher than its fundamental value.

One common way of thinking about housing's fundamental value is to consider the ratio of housing prices to rents. ... Currently, the ratio for the U.S. is higher than at any time since data became available in 1970 ... Higher than normal ratios do not necessarily prove that there's a house-price bubble. House prices could be high for some good, fundamental reasons. ... Probably the most obvious candidate for a fundamental factor ... is low mortgage interest rates. ... While the fundamentals I've mentioned do play a role, the consensus seems to be that much of the unusually high price-to-rent ratio for housing remains unexplained. Moreover, with controversy over exactly why long-term interest rates have remained so low, we can't rule out the possibility that they would rise to a more normal relationship with short-term rates, and this obviously might take some of the "oomph" out of the housing market. So, while I'm certainly not predicting anything about future house price movements, I think it's obvious that the housing sector represents a risk to the U.S. outlook.

This brings me to the debate about how monetary policy should react to unusually high prices of houses—or other assets, for that matter. ... As a starting point, the issue is not whether policy should react at all; I believe there is quite general agreement that policy should be calibrated to the wealth effects of house prices on output and inflation. The debate lies in determining when, if ever, policy should be focused on deflating the asset price bubble itself. In my view, the ... decision to deflate an asset price bubble rests on positive answers to three questions. First, if the bubble were to collapse on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?

My answers to these questions in the shortest possible form are, "no," "no," and "no." ... In answer to the first question on the size of the effect, it could be large enough to feel like a good-sized bump in the road, but the economy would likely to be able to absorb the shock... In answer to the second question on timing, the spending slowdown that would ensue is likely to kick in gradually... That would give the Fed time to cushion the impact with an easier policy. In answer to the third question on whether monetary policy is the best tool to deflate a house-price bubble, ... For one thing, no one can predict exactly how much tightening would be needed, or by exactly how much the bubble should be reduced. Beyond that, a tighter policy to deflate a housing bubble could impose substantial costs on other sectors of the economy that would lead to equally unwelcome imbalances. Finally, it's possible that other strategies, such as tighter supervision or changes in financial regulation, would not only be more tailored to the problem, but also less costly to the economy. Taking all of these points into consideration, it seems that the arguments against trying to deflate a bubble outweigh those in favor of it. ... But let me stress that the debate surrounding these issues is still very much alive.

By June 2009, her views had evolved:

Panel discussion for the Federal Reserve Board Journal of Money, Credit, and Banking conference on "Financial Markets and Monetary Policy," by Janet Yellen, President FRBSF: My second point concerns asset prices. The role of the house price bubble in precipitating the current financial crisis places new urgency on a long-standing question: Should central banks attempt to deflate asset price bubbles before they grow large enough to cause big problems? Until recently, most central bankers would have said monetary policy should respond to an asset price only to the extent that it will affect the future path of output and inflation. In essence, if you believe that financial markets work well most of the time, then you would be highly reluctant to target asset prices, let alone pop asset price bubbles. But, as I have discussed, we have vivid proof that markets sometimes don't work, and that the unwinding of a bubble can dramatically harm economic performance and threaten financial stability.
Four main issues define this debate... First, some question whether bubbles even exist. They argue that asset prices reflect the collective wisdom of traders in organized markets who best understand the fundamental factors underlying asset prices. It seems to me that this argument is difficult to defend in light of the poor decisions and widespread dysfunction we have seen in many markets during the current turmoil.
Second, it's an open question whether policymakers can identify bubbles in time to act effectively...
Third, even if we can identify bubbles as they happen, using monetary policy to address them will reduce our ability to attain other goals, so it makes sense for monetary policy to intervene only if the fallout is likely to be quite severe and difficult to deal with after the fact. ... By their nature, credit booms are especially prone to generating powerful adverse feedback loops between financial markets and real economic activity.4 If all asset bubbles are not created equal, policymakers could decide to intervene in those cases that seem especially dangerous.
Fourth, if a dangerous asset price bubble is detected and action to rein it in is warranted, is conventional monetary policy the best tool to use? Going forward, I am hopeful that capital standards and other tools of macroprudential supervision will be deployed to modulate destructive boom-bust cycles, thereby easing the burden on monetary policy.5 However, I now think that, in certain circumstances, the answer as to whether monetary policy should play a role may be a qualified yes. In the current episode, higher short-term interest rates probably would have restrained the demand for housing by raising mortgage interest rates, and this might have slowed the pace of house price increases. In addition, tighter monetary policy may be associated with reduced leverage and slower credit growth, especially in securitized markets.6 Thus, monetary policy that leans against bubble expansion may also enhance financial stability by slowing credit booms and lowering overall leverage.
Certainly there are pitfalls to trying to deflate bubbles. At the same time, policymakers often must act on the basis of incomplete knowledge, and it is now patently obvious that not dealing with some bubbles can have grave consequences. I would not advocate making it a regular practice to lean against asset price bubbles. But, in my view, recent painful experience strengthens the case for using such policies, especially when a credit boom is the driving factor.

    Posted by on Friday, March 12, 2010 at 11:34 PM in Economics, Monetary Policy | Permalink  Comments (45)


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