Janet Yellen’s confirmation hearings, the latest step en route to her appointment as the next Federal Reserve Chair, provided few surprises. Her overall message was one of continuity rather than change. Still, Dr. Yellen’s
prepared comments and her responses to the questions that followed highlight several take-away points that help us understand where the Fed will head under her leadership.
First, and most important, Dr. Yellen acknowledged her own role in formulating the two percent long-run inflation target adopted by the Federal Open Market Committee (FOMC) last year, and reaffirmed her continuing commitment to that target. By doing so, Dr. Yellen sent a powerful message to American workers, consumers, business owners, and financial market participants. The two percent inflation target recognizes that, as our nation’s central bank, the Federal Reserve alone has the responsibility for controlling inflation in the long run. The explicit inflation target also reflects the results of a great deal of economic research that shows that by stabilizing prices first, the Fed provides the preconditions that best promote growth in incomes and employment—even in the short run. Anchored by a commitment to this two percent target, Federal Reserve policy under Janet Yellen will never allow Americans to suffer through another “Great Inflation,” like they did during the 1970s, or Great Depression, like they did during the 1930s.
Second, at the hearings Dr. Yellen reiterated her position that since 2008 monetary policy has been too restrictive more often than it has been too loose. To support this idea, Dr. Yellen pointed to the stubbornly high rate of unemployment. But a similar message follows from examining the behavior of inflation itself, which for more than five years in a row has come in below the two percent rate that the Fed is now targeting. Persistent gaps between actual and targeted inflation almost always reflect sluggish growth in broader measures of the money supply. Dr. Yellen is right to anticipate that the Federal Reserve’s bond-buying programs will one day have to end and interest rates will have to rise. But observers who focus on the behavior of money growth and inflation as indicators of monetary policy stance will share her view that the Fed must exercise caution and not tighten policy too much, too soon; otherwise, the still hesitant economic recovery will be put in jeopardy.
Third, Dr. Yellen confirmed that while considerable progress has been made, more needs to be done to eliminate the problem of “too big to fail” that still hangs heavy over our financial system and the economy as a whole. Although the Federal Reserve and other regulatory agencies are themselves partly to blame for not recognizing the build-up of risks that preceded the 2008 financial crisis, the truth is none of the private institutions that took on that risk would have rationally done so had their management and employees not recognized—correctly, as it turns out—that the U.S. government would help cover their losses at the expense of the American taxpayer. Stricter capital requirements and liquidity rules, as Dr. Yellen mentioned, will help greatly in stabilizing the financial system. But leaders in the legislative and executive branches of our national government could do even more by pledging publicly, in no uncertain terms, that insolvent financial institutions, no matter how large or important, will at all points in the future be shut down and liquidated like any other bankrupt corporation. Only then can the free market operate, as it should, to promote the success of more efficient businesses and to reward the hard and honest work of their employees.
Finally, Dr. Yellen rightly praised the current Federal Reserve Chair, Ben Bernanke, for his efforts in making the Fed and its policymaking processes more open and transparent, and vowed to continue working along the same lines. This last point deserves some further reflection. History teaches us that the activities of secretive government agencies operating beyond the public’s consent or control are simply inconsistent with the functioning of a healthy democracy; they are, instead, the stuff of medieval kings, defeated fascist despots, failed communist dictatorships, and crumbling authoritarian regimes that, elsewhere around the world even today, are being pulled down by the far more powerful will of the people. By reminding us of this basic lesson, Janet Yellen’s confirmation hearings more than served their purpose.
Peter Ireland is a professor of economics at Boston College and a member of the Shadow Open Market Committee.