Janet Yellen: What's Ahead for the Fed?

When Ben Bernanke completes his second term as Federal Reserve Board chairman in January, Janet Yellen should be more than ready to take the helm of the U.S. central bank, according to Wharton faculty and other experts. Current Federal Reserve Board vice chairwoman Yellen, appointed on October 9 by President Obama to succeed Bernanke, is widely respected as a first-rate academic economist with decades of real-world experience in monetary policy.

While serving as San Francisco Federal Reserve Bank president, the Yale-trained PhD economist sounded early warnings about housing market risks that soon proved correct when the 2008 financial crisis hit. A former Clinton administration Council of Economic Advisors chairwoman and University of California at Berkeley professor, Yellen, if confirmed, would become the first female Fed chief.

The Fed, which has changed its modus operandi dramatically since the financial crisis, is in great need of a steady hand to steer it through many unknowns, including any fallout from the unprecedented $85-billion-a-month asset purchases started under Bernanke, experts say. Indeed, under the watchful eyes of investors, Yellen “will have to navigate uncharted waters in the coming years,” says Wharton finance professor Joao F. Gomes.

Quantitative Easing: Beginning of the End

Unlike current Fed chief Ben Bernanke, who enjoyed a relatively quiet first year in office before the financial crisis let loose, Yellen is likely to experience trial by fire from the get-go. Looming on her agenda is the closely monitored decision on when to start winding down the Fed’s massive bond buying program, which was instigated by Bernanke after the 2008 financial crisis to stimulate the U.S. economy.

“Tapering will be the first thing [Yellen] will be judged on after she takes office.”–Joao F. Gomes

The Fed has already come under fire for sending confusing signals on the tapering of its so-called quantitative easing (QE) policy. In June, Bernanke said the taper could start when the unemployment rate hits 7%. In August, the unemployment rate dropped much faster than expected to 7.3%, and investors widely believed the central bank would start winding down QE in September. Yields on 10-year Treasury notes and mortgage rates rose in anticipation. But in September, the Fed punted the decision, unwilling to end the stimulus when Washington’s brinksmanship over the budget deficit and debt ceiling continued to feed economic uncertainty.

Now, “tapering will be the first thing [Yellen] will be judged on after she takes office,” says Gomes. “Unavoidably, the decision will affect the financial markets, depending on whether she handles it well or not. She will have to find a way to establish herself very quickly.” However, he adds, Yellen is unlikely to spring any surprises. Besides strongly supporting clear communications to the public, she “has definite views of what works and doesn’t work, and you’ll naturally have the sense she will lean one way or another on any particular decision,” Gomes notes.

Unemployment in the spotlight

How would Yellen approach her decision to start winding down QE? With a reputation as a monetary policy dove who is more accepting of low interest rates to stimulate employment and growth, will she take a go-slow approach on the taper? In her confirmation hearings, Yellen will have to assure senators that she serves both sides of the Fed’s dual mandate, conferred by Congress, to ensure price stability and maximum employment alike. “She has to thread the needle between the Democrats, who want assurances for further supports for the economy, and the Republicans, who are concerned that [continuing] QE forever will give rise to asset bubbles that will set up the next crisis,” says Phillip Swagel, a University of Maryland public policy professor and former assistant secretary of economic policy at the Treasury during the George W. Bush administration.

With unemployment continuing to dog the recovery, though, Yellen may be just what is required for the times, according to Wharton finance professorKrista Schwarz. While Bernanke spent most of his academic career studying lessons of the Great Depression and ended up presiding over one of the worst financial crises in decades, Yellen, an expert in labor markets, may be uniquely qualified to address the current labor market malaise, notes Schwarz. “Yellen’s research has focused on the cost of long-term unemployment and the danger of a high unemployment rate, making a problem that’s cyclical turn into one that’s structural.” Yellen has co-authored studies with her husband, Nobel Prize winner George Akerlof, on the role of monetary policy in stimulating employment growth.