Every Federal Reserve Board chairman comes into office with a secret agenda, a hidden passion. It's the sort of thing you don't hear about at the confirmation hearings, and yet it is often this grand passion—suddenly given voice in the world's bulliest economic pulpit—that shapes the nation's future in unexpected ways. Alan Greenspan, the erstwhile "maestro" of the Fed, wanted to turn finance into the kind of laissez-faire market that his mentor Ayn Rand, the uber-libertarian author, had always envisioned. The result was the across-the-board deregulation of banking. When Ben Bernanke took over Greenspan's job, he appeared to be just another conservative economist in the mold of his predecessor (who had endorsed him). But his great passion was applying his life's work as a scholar of the Great Depression to stop another one. Only people who really knew Bernanke were aware of how the balding, mild-mannered man with the slightly quavery voice was committed, body and soul, to ensuring that the 2010s did not turn out like the 1930s. Thus, the startling spectacle of a Republican-appointed activist chief exploding the Fed's balance sheet by trillions of dollars to keep the economy going.
What is Janet Yellen's secret passion? By the accounts of her friends and colleagues, the 67-year-old Yale-trained economist doesn't have many secrets. She's served nearly 10 years in the Federal Reserve system, first as a governor, then as head of the San Francisco Fed, and now as vice chairwoman. Before that she ran the Council of Economic Advisers under Bill Clinton. "If you were dreaming up a training school for Fed chairmen, it would be her life story," jokes Princeton economist Alan Blinder, her former colleague at the Fed. "I don't think anybody in the Fed's history has come in with such a full résumé of Federal Reserve experience." As a result, she's probably as open a book as any nominee for chief in history. Yellen is considered a non-ideologue who will relentlessly follow the facts, whether they lead her toward solutions on the left or the right. "She is truly a scientist, in that she is an observer," says Jim Adams, a University of Michigan economist who has known Yellen since the 1970s. In her actions on the Federal Reserve Board and in her agonizingly deliberate, Brooklyn-accented testimony before Congress, Yellen has resolutely toed the traditionalist middle line on the Fed's "twin" mandates to manage inflation and unemployment. And with her ready smile, pixie haircut, and diminutive size (5 feet), she doesn't look like much of a bomb-thrower.
But that is the public Janet Yellen. Disciplined, determined, and brilliant, Yellen is also the product of an old progressive tradition of activist, pro-government economics. Above all, according to colleagues, she takes the nation's worst problems, especially unemployment, as a deeply personal challenge. Yellen, who is all but certain to be confirmed, represents a strain of interventionist thinking that has not found expression at such a high level in Washington in decades—at least since Ronald Reagan and his Milton Friedman-inspired attempt to shrink the size of government. That philosophy still dictates the agenda; even the last two Democratic presidents, Clinton and Barack Obama, have advanced (or bowed to) get-government-out-of-the-way policies, and the GOP's no-new-tax religion prevents any concessions for a broader budget deal.
Yellen, unlike Greenspan or a pre-2008 Bernanke, is probably the last person you'd hear repeating one of Reagan's favorite jokes: "The nine scariest words in the English language are: 'I'm from the government, and I'm here to help.' " According to more than a half-dozen longtime friends and colleagues, she has two grand passions that will require government to help in a very big way: reducing chronically high unemployment—which is the focus of her life's work and is probably the single biggest economic problem in America today—and reining in Wall Street's excesses. Yellen already appears to be settling the Fed's eternal debate about the relative threats of unemployment and inflation; she declared bluntly in her testimony that joblessness is the issue of the moment. Based on her past positions, she is also likely to try to alter the discussion in Washington on issues ranging from the size and power of the big banks to the need for a higher minimum wage and extended jobless benefits. And at a time when Obama has declared that income inequality is "the defining challenge of our time," and polls show that a majority of Americans no longer believe their country offers equal opportunity to all, Yellen brings a raft of well-thought-out—and decidedly activist—views to these issues.
She has devoted much of her career to showing why markets fail so often and therefore government intervention is needed, says Nobel Prize-winning economist Joseph Stiglitz, her former teacher at Yale and a longtime friend. Far more than previous Fed chiefs, Yellen also embraces the young field of behavioral economics, which posits that people often don't act rationally the way economic models say they should. Yellen knows that the Fed's traditional powers are limited now because the economy may be caught in a "liquidity trap," with interest rates already so low that additional injections of cash by the central bank will do little or nothing to stimulate the economy. But she is constantly on the hunt for novel interventionist solutions; "out of the box" is one of her favorite phrases. "She knows that labor markets don't work perfectly; capital markets don't work perfectly," Stiglitz says. He adds that Yellen understands that monetary policy is itself the best proof of this thesis—because it wouldn't be needed at all if markets always worked correctly.
Those who have known Yellen the longest also hail her empathy. They say she feels the pain of the jobless on a gut level and has even scolded her fellow economists for treating the unemployment rate as a mere number rather than a tragic encapsulation of the misery of millions. "How deeply you care about the unemployed comes in part from your viscera rather than your intellect. And with Janet Yellen, it's very strong," Blinder says. "She spent a good part of her career studying why unemployment stays high. I can remember a conversation between the two of us at the Fed in the '90s—I was vice chairman and she was a governor. One day, we tried holding back [the Federal Open Market Committee, the Fed's chief decision-making body] from going overboard on raising interest rates. She said, 'Maybe we saved 500,000 people their jobs.' "
Now she gets her chance to save more. Alongside inequality, chronic unemployment is America's most pressing economic problem. The bleak backdrop to the latest positive news, the reduction in the unemployment rate to 7 percent, is that devastating numbers of people have simply dropped out of the workforce in despair. And yet Washington policymakers remain ideologically paralyzed over what to do about it. By a number of accounts, no one feels this more intensely than Yellen, who understands not just the human cost to individual lives and families but also the damage that a demoralized workforce can do to the economy as a whole. One of her most important papers, written with her husband, Nobel Prize winner George Akerlof, showed that workers who feel underpaid will be less productive. "She does see long-term unemployment, massive unemployment, as not only an economic problem or in terms of wasted resources but also as a human being," says John Williams, president of the San Francisco Fed, who was Yellen's research chief when she ran it. "It is very destructive to families.… This is passionate with her. Among economists, you don't often see that human side. With her, it's not just an abstraction, and if you try to treat it too much as an abstraction, she'll react."
Williams says he was "mildly chewed out" by Yellen for approaching the mortgage crisis too academically—too much like an economist. "We need to be working our hardest, thinking our best.… This country's in a crisis. We're on the precipice, and we need to really focus," he recalls her saying. Yellen, he adds, is not going to be the type of Fed chief "sitting there wringing her hands and saying monetary policy can't solve all the world's problems."
Already she is describing the central bank's job in ways that have stunned some traditional Fed watchers—and made them uneasy. Yellen's very first statement after Obama nominated her in October suggested she intends to extend Bernanke's revolutionary expansion of the Fed's role, not ratchet it back. "While we have made progress, we have further to go," she said, adding that the Fed's job was not just to keep the dollar sound but "to serve all the American people ... [and] ensure that everyone has the ability to work hard and build a better life."
The statement, which indicated that Yellen is focused on boosting employment, "knocked me over. It was a political statement which fits perfectly with her [academic] upbringing," says David Jones, a veteran Fed analyst and the author of the forthcoming book Understanding Central Banking: The New Era of Activism. He points out the risks. "Her biggest challenge now is to reverse the Fed's highly accommodative policy," but that runs right up against her activist approach to unemployment and income inequality. As a result, Jones is worried that Yellen will make a muddle of the job. "The trouble is, you don't know whethershe can rise to the level of that pay grade, which is the second-most-powerful person in the country," he says. "She also said that the greatest quality of the Fed is its ability to debate issues. I said to myself, debating issues is as far removed from the Fed's greatest quality as I can think of. It's the policy the Fed makes that counts."
The daughter of a Brooklyn physician and a homemaker, Yellen grew up fairly well-off in the halcyon '50s. But she vividly remembers listening around the kitchen table as her father told tales of the Depression and her mother read about markets and economics from the business section of the newspaper. A math geek and the valedictorian of her high school class, Yellen adored the idea that people could actually figure out how a whole economy works and maybe even rescue it, as John Maynard Keynes proposed. She was drawn to Yale because her mentor, the famous liberal economist James Tobin, a Keynes acolyte, talked in passionate terms about preventing the terrible joblessness of the Depression, and the financial recklessness that led to it, from ever happening again.
So even though it's well out of the Fed's purview, Yellen has for years done academic work supporting a higher minimum wage and dealing with income inequality. Previous Fed chairmen have tended to shrink in horror from such legislative issues, but as far back as 2006, while president of the San Francisco Fed, she warned that rising inequality could "undermine American democracy" and that dramatic improvements in education were "imperative," along with a strengthening of the social safety net. It would be surprising if she did not try to convince Congress of the same in speeches and her semiannual testimony.
And then there is the rest of the globe. Stiglitz says that in such a powerful position—the most powerful economic post in the world, and the second-most-powerful job in Washington—Yellen could profoundly change the debate around the world. Despite growing concern about inequality, central bankers in many countries (especially at the European Central Bank) tend to support "wage flexibility," which is a fancy term for permitting economic policies that drive wages down and thus create more inequality to attract businesses, says Stiglitz, who consults for many of those nations. Yellen, as the world's most influential central banker, is likely to try to alter that conventional wisdom and other reflexively neoliberal (read: Reaganite) views.
Today, Yellen sees the economy as a great ailing beast, and she wants to massage it back to life. She knows that America is in danger of becoming like Japan, with chronically slow growth that leaves real interest rates low for a long time and tends to render the Fed chairman's traditional array of monetary tools ineffective. Even so, "there is a lot of intangible influence that a Fed chairman brings to the table," says Jared Bernstein, Vice President Joe Biden's former chief economist. "When it comes to just the basic problem of structurally deficient demand and persistent output gaps [the difference between what the economy could be producing and what it is], and of long-term unemployment, she seems to really get not only how important it is to attack those problems for the benefit of people who are hurt by them, but also for the macroeconomy. She recognizes that the longer the cyclical problems go on, the more they morph into structural problems"—in other words, the more they become a permanent condition.
Other supporters say it is the sheer breadth of Yellen's economic thinking that is most impressive—and useful. "I do think she does represent something of a new breed of policymakers in Washington," says John E. Kwoka, an economist at Northeastern who graduated with Yellen from Brown in 1967 and has followed her rise to the top with frank admiration. "She has wider knowledge of modern economics than certainly Alan Greenspan but probably Ben Bernanke, too.… And she's not part of the Washington-New York axis, which for some time has been controlling Fed and Treasury policy. That's why I think she's the perfect match for the issues of the day."
Yellen will also be inheriting a job that has never been as important as it is right now. "Bernanke has established monetary policy as the most powerful weapon the government can use in dealing with a crisis," overturning the post-Great Depression Keynesian focus on fiscal spending, Jones says. The question now is whether Yellen will try to out-Bernanke even Bernanke. Whatever Yellen's ambitions for shifting the debate in Washington—on minimum wage and income inequality, or on more fiscal stimulus or job programs—at the beginning of her term, she will be saddled with one big, decisive question: when to begin to "taper" or unwind Bernanke's latest aggressive intervention in the market, his "quantitative easing" program of buying $85 billion a month in bonds to keep interest rates down. As a Fed veteran, she may also be leery of jumping too quickly into the fiscal debate, fearing a backlash from a Congress that keeps threatening to rein in the Fed's traditional powers. Blinder and others say they expect Yellen to be cautious at first, in part because a bloc of dollar hawks such as Sen. Marco Rubio, R-Fla., have come out against her nomination, saying she and Bernanke have laid the groundwork for massive inflation. Jeffrey Frankel of the Harvard Kennedy School, who served under Yellen on Clinton's Council of Economic Advisers, says he thinks she might surprise everyone at first by tightening monetary policy sooner rather than later, "partly maybe to establish her reputation and make it clear that she's not just a soft-money person."
Senators who listened to her confirmation testimony also see a lot of continuity with Bernanke, with whom Yellen has worked smoothly as vice chairwoman for the past three years. "Not to sit down at a spreadsheet and compare the two, but I think they're pretty similar in their philosophies," says Sen. Jon Tester, D-Mont. "I mean, they could vary in other things that I'm not aware of, but I think that she's going to be a pretty steady hand at the Fed, because that's what Bernanke has been." Bernanke himself is said to be delighted with the choice, in large part because she will deliver the smoothest possible transition. As Mark Gertler of New York University, Bernanke's longtime coauthor and intimate friend, puts it, "She was his biggest advocate at the board, no question about it.… I remember meeting with her very early in the crisis, and her remarking on how well he was doing. She wants it to look seamless. No question about that. I think he probably feels good about leaving now."
Like Bernanke, of course, Yellen's biggest problem will be Washington's political dysfunction, especially the inability of Congress and the president to agree on a long-term budget, on how progressive the tax code should be, or on any additional fiscal stimulus. "What the Fed has had to do is to compensate for the absence of fiscal policy. That's not a healthy situation," Gertler says. "If it were not for the craziness going on in Congress, the Fed would probably be unwinding [its quantitative-easing policies] right now. It's going to be tough—different from what Bernanke had to deal with. He was fighting a lightning strike, with the crisis. This is more like a steady consistent battle she's going to have to fight." But while she isn't likely to come out swinging against the congressional intransigents, many of her friends and associates say it would be in character for her to use her powers of persuasion to quietly sway the larger debate. For her entire career, they say, she has been fearless about standing up for the economic views she believes are right. Michigan's Adams tells of getting to know her when he was a Ph.D. student at Harvard and Yellen was an untenured assistant professor there. Adams had just been rebuffed by his thesis adviser, an emeritus chairman of the economics department. When Adams told Yellen that his adviser had instructed him to rethink his economic argument, she replied calmly, "Hmm, it seems to me we could do something." Together, Yellen and Adams collaborated on an article advancing the same ideas; it became one of the most heavily cited in the field. "Janet was right. My thesis mentor was wrong. And what came out of it was much more than I had seen myself. Janet saw how to make it into something much better." Just as important, she was taking on a powerful tenured professor who could have easily voted her out of a job at a faculty meeting. "That takes some courage," Adams says. It's the kind of courage she will need to take on—in testimony, speeches, and meetings with legislators and regulators—an entire free-market Zeitgeist, the Reaganomic views that still dominate Washington.
Wall Street, Watch Out
Yellen is also said to be pushing for a far more aggressive approach to Wall Street—which is ironic, considering that Wall Street has cheered her nomination. Officials inside the Fed and out who have spoken to her say one big change in the offing is that Yellen plans to take charge of the financial-regulatory agenda herself, while Bernanke largely left the task to one of his governors, Daniel Tarullo. (Despite a shared perspective—that banking needs to be more heavily regulated with tough capital and liquidity ratios and restrictions on risky trading and lending—Yellen and Tarullo have battled over turf. (See "High Noon for Dan Tarullo,") Says one economist who knows her well: "The feeling I think she has is that Dan was given license [by Bernanke] and he treaded too lightly. He was not as forceful as he needed to be. She feels that the chairman has much more impact."
Her view is that financial markets have and will continue to fail disastrously unless they are further constrained, sources close to her say. Already it appears that Yellen is prepared to tussle with Treasury Secretary Jacob Lew, who despite showing more enthusiasm for bank regulation than his predecessor, Timothy Geithner, suggested recently that the too-big-to-fail problem has been largely solved. In her own public remarks, Yellen echoes Tarullo's push for higher capital standards for "systemically important" banks, to prevent them from over-leveraging and running out of cash. And she also repeats his concerns about restricting the use of wholesale short-term funding markets, which seized up in the 2008 crisis and doomed Lehman Brothers. Tarullo has been more aggressive than Lew and the Obama administration in proposing what he's called a "set of complementary policy measures" to go beyond the Dodd-Frank law. Among them: limiting the expansion of big banks by restricting the funding they get from sources other than traditional federally insured deposits.
Yellen, in a major speech in Shanghai last June, went beyond what Bernanke has said by explicitly endorsing some of Tarullo's efforts. "I'm not convinced that the existing [systemically important financial institutions] regulatory work plan, which moves in the right direction, goes far enough," she said. She also spoke of doing much more, as Tarullo has, to constrain the "shadow banking" sector that caused so much trouble in 2008, including broker-dealers and money-market funds. Yellen said "a major source of unaddressed risk" were the hundreds of billions of dollars of short-term securities financing used by these firms, adding, "Regulatory reform mostly passed over these transactions."
More than that, as economist Kwoka suggests, Yellen is a rara avis in Washington these days—someone who has spent her life and career utterly detached from Wall Street. "Janet represents a return to the desanctification of finance," says an economist who knows her views well but would speak about them only on condition of anonymity. "I think that's a huge sociological change. She's not captured by Wall Street the way so many have been.… I think Janet will be more active. When it comes to financial innovation, it used to be, 'You can do it unless we say no.' Now I think the policy will be, 'You can't do it unless we authorize it.' " Because the Fed has the power to regulate and write rules for the giant bank holding companies, it has enormous discretion in this area and does not need to wait for Congress to act.
Still, even on Wall Street, it's hard to find people who will say negative things about Yellen, who was recently judged by The Wall Street Journal to be the most accurate forecaster on the Federal Reserve Board. It's easier, in fact, to track down the negative assessments that Yellen occasionally makes of herself. While she did not always act on regulation when needed—claiming that as head of the San Francisco Fed she had to wait on Washington's guidance—the record shows she appeared to be somewhat ahead of Bernanke in appreciating the dangers of the securitization-led housing bubble. At the Fed's June 2007 meeting, she warned that the failing housing sector was the "600-pound gorilla in the room." That was only a month after Bernanke, in congressional testimony, said he saw only a "limited impact" from subprime mortgages on "the broader housing market." Yet Yellen also offered up a personal mea culpa after the financial collapse, telling the Financial Crisis Inquiry Commission in 2010 she "did not see and did not appreciate what the risks were with securitization, the credit-ratings agencies, the shadow banking system, the [structured investment vehicles]—I didn't see any of that coming until it happened."
A few economists wonder whether Yellen may end up being more middle-of-the-road than her academic record indicates. As a resolute free-trade advocate, she's probably far more centrist than, say, Jared Bernstein, and she's not nearly as interventionist as Joseph Stiglitz, who during the 1990s fought a losing battle against opening up capital flows around the world. Yellen is probably even less liberal than her husband, who shared a Nobel Prize with Stiglitz, and her late teacher, James Tobin, the Nobel Prize winner from Yale who argued that financial markets are more inherently prone to failure than ordinary markets in goods and services. In a 2010 interview, Akerlof said he "was always apoplectic" about the kind of rapid deregulation advocated by Harvard economist Lawrence Summers, who almost certainly would have been nominated in Yellen's place had he not backed out. As Clinton's CEA chairwoman, by contrast, Yellen did not demur from some deregulatory moves such as Glass-Steagall repeal in 1999.
Nonetheless, by her own account, Yellen represents the government-activist "Yale School" of economics, which believes that there are "clear answers to key questions dividing macroeconomists, along with policy prescriptions," as she put it in a 1999 speech at Yale. "Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not. Are deviations from full employment a social problem? Obviously." She is, more than previous Fed chiefs, an old-style "hydraulic Keynesian" who believes she can act as a control engineer over the economy, printing money to drive down unemployment. The two previous chairmen going back to the late 1980s have tended toward the Chicago libertarian side of economics, exalting the wisdom of markets.
The biggest problem Yellen will face in her term is that she has a steep hill to climb to bring government back into the discussion in an enlightened way—especially on the heels of the troubled rollout of Obamacare. And if America is entering "secular stagnation" where monetary policy is no longer very effective because interest rates are already so low, then her influence may be far more limited than, say, Greenspan's was in the heyday of "irrational exuberance." But, eventually, Gertler says, "she's going to carve her own niche," perhaps by expanding the Fed's mandate to target higher GDP growth and further restraining Wall Street.
The past several Fed chiefs have all seemed oddly suited to their moments. The cigar-chomping Paul Volcker was just the man to tame runaway inflation in the '70s and '80s. Greenspan, despite his errors on deregulation, was the right Fed chairman to handle the era of irrational exuberance and sudden productivity growth in the 1990s (one of his lesser-sung triumphs, in fact, was to hold off raising rates at a time when many economists, including Yellen, were urging him to worry about inflation—and he probably saved millions of jobs that way). "Helicopter Ben" Bernanke, of course, was just the savior we needed to prevent another Great Depression.
In the end, all of these Fed chairmen profoundly changed the course of the U.S. economy (and Volcker, though in retirement, is still doing so with the just-approved "Volcker Rule" that will bar banks from the riskiest trading). There is every reason to think Janet Yellen will have just as much impact, in her own special way.
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