There are no fast rules for running the Federal Reserve, but Janet Yellen has a few.
Rule No. 1: Be methodical and transparent.
Rule No. 2: See rule No. 1.
Even before President Barack Obama nominated her Wednesday to lead the Fed, Yellen advocated a rigorous, predictable approach to steering the nation’s economy. In speeches in 2012, for instance, she talked about the virtues of using a mathematical formula to help determine when the central bank should raise or lower interest rates. Plug in economic growth, inflation and the like and you have a decent guidepost for what policy should look like.
At least in theory. In practice, setting monetary policy rarely comes down to one equation. And not even Yellen is advocating a policy-by-the-numbers approach just now, given the fragile state of the economy.
But in public speeches and academic work, she has suggested that the Fed should be more systematic, predictable and transparent — in short, that it should lay down some rules and stick to them. It is a template that Wall Street likes, and one that underscores the Fed’s departure from the days of Alan Greenspan, its chairman from 1987 to 2006, whose Delphic pronouncements were endlessly parsed by economists and investors.
Investors hope that a Yellen Fed will clearly telegraph its intentions to the financial markets, particularly as the central bank begins to taper its efforts to kindle growth. On Wednesday, that view was reflected in the stock market, which rebounded after two straight days of losses, in part on hopes that Yellen, if confirmed, would not rush to withdraw stimulus. The dollar also strengthened.
On Wall Street and in Washington, the view is that Yellen will generally maintain the policies of the current chairman, Ben Bernanke, while pressing for even greater transparency. In interviews, people who have known Yellen and her work frequently use the same word to describe her: “methodical.”
“She thought of things through models that were very methodical and transparent,” said someone who worked alongside her when she was at the president’s Council of Economic Advisers from 1997 to 1999. “It wasn’t like Alan Greenspan where you can’t quite follow what he’s saying, whether he has a superior model or is just confused. With Janet you could follow every step” and imagine all the assumptions and models she was working from in her head.
Even those who disagree with what the Fed has done under Bernanke praise Yellen, currently its vice chairwoman, for her stated commitment to having stricter, clearer guidelines.
“Janet is more interested and concerned with policy being more predictable, rules-based, that markets have some sense of where policy is headed over a long period of time, that you’re transparent about your future behavior and you can actually stick to it,” said John Taylor, an economics professor at Stanford, who said the Fed’s policy had been too accommodative.
Taylor is best known for “the Taylor rule,” essentially a mathematical equation that guides how the central bank should set interest rates in response to changes in inflation, output and other economic measures. Yellen, in speeches in April 2012 and November 2012, spoke about variants on this rule and the usefulness of such “simple rules” for guiding policy, although in the November speech she said she was not ready to enact such a rule now because these are not “normal times.”
Despite Yellen’s reluctance to follow strict rules in setting policy immediately, Taylor still is heartened by her stated desire to return to them eventually and the specificity with which she has laid out what her preferred “rule” would look like.
“In that speech, she put on paper what she’s talking about, what the rules are,” said Taylor, who devotes a graduate course lecture to weighing his preferred interest-rate-setting rule against a variant Yellen has described. “Now people can understand them and have the opportunity to discuss the pros and cons. Without that framework, you’re just talking about things in the abstract.”
He said that the lack of rules-based policy had caused chaos and volatility in the markets — particularly when it comes to scaling back its ongoing major asset purchases, known as quantitative easing (also called, in its latest incarnation, QE3).
“You can see it with this taper/no taper,” he said. “September last year, they started QE3. Then in December they doubled it. Five months later they said they’d start the taper soon, then they have reversed themselves again. You can see it in the markets. Nobody knows what is actually going on.”
Yellen voted alongside Bernanke and a majority of the Federal Open Market Committee for the actions related to starting, increasing and continuing quantitative easing. But Taylor still believes that a Fed under her leadership would shift back to more “normal” rules-based policy than it is inclined to do now.