It's Too Early to Assess Yellen's Legacy

(Bloomberg View) -- The vast majority of those contemplating Federal Reserve Chair Janet Yellen’s legacy point to the deep decline in the jobless rate, which satisfies the central bank's mandate of maximizing employment. They look past its inability to fulfill its second mission of hitting the arbitrary inflation target of 2 percent. The stock market at record highs is typically thrown into the mix for good measure.

But what about financial stability?

If there is one thing that can be said of Yellen’s 14-year career at the Fed, which ends Feb. 2, it is that she was persuasive. The recently released transcripts of the 2012 Federal Open Market Committee meetings illustrate her acumen in the face of skepticism.

Two intense debates were taking place when members of the committee convened in October of that year. Should the Fed intensify its forward guidance by committing to keep quantitative easing up and running until certain objectives for the unemployment rate and inflation were met? And should the monthly size of QE purchases increase?

Among the skeptics were Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser, but also the two newest members of the Board of Governors, Jerome Powell and Jeremy Stein. The correct concern was that setting an unemployment "target" would communicate to the public a "trigger," a word used 34 times at that October meeting. They meant to signal that once the trigger was tripped, QE would stop.

Powell said:

Unemployment is just very tough. For one thing, as President Plosser was pointing out, there are just so many aspects of the labor market that we need to consider. I also think we’re going to be read as setting a target, when we just got done telling the market that we don’t have a target.

This would be one of the many times the rookie Powell voiced concerns about the dangers of confusing the public and losing credibility along the way.

Of course, as has been the case for more than 30 years, the doves prevailed.

Yellen, who was president of the San Francisco Fed from 2004 to 2010, became Fed vice chair in 2010 and chair in 2014, explained then:

Spelling out explicit thresholds for action is a way for us to communicate a commitment to keep rates lower for longer, and it provides the public with a way to monitor whether or not we’re actually sticking to that commitment as the recovery proceeds and unemployment declines toward more normal levels.

As for the inflation target that the Fed never seems to hit, Yellen was a wholehearted advocate of continuing to use the same broken metric that caught the Fed off guard in the years leading up to the financial crisis. Former Vice Chairman Stanley Fischer was one of the most eloquent critics of the core PCE -- personal consumption expenditures net of food and energy prices -- because it understates residential real estate prices and doesn’t capture asset price inflation.

Nonetheless, that metric is still employed. Yellen said:

Current four-quarter core PCE inflation is one of the best predictors for headline PCE inflation over the next two years. I support threshold values of 6½ percent for the unemployment rate and 2½ percent for inflation and agree with Governor Tarullo and with Vice Chairman Dudley that setting tighter thresholds would imply withdrawing accommodation, and that’s something I would certainly oppose.

"Oppose" may have been too tame a word to use when it came to unplugging the QE. Time and again, Yellen pushed for a more aggressive stance. Not everyone around the table shared her enthusiasm.

“I take President Fisher’s point that we should not prematurely pat ourselves on the back,” Yellen conceded, “but overall I think our actions did elicit the financial market responses we expected, and that does serve to raise my confidence that our asset program will be efficacious over time, especially in providing support to the housing market.”

Speaking of housing, both renting and buying are more expensive than ever, a development that has eviscerated the paycheck-to-paycheck cohort. The worst of the run-up has occurred in the most recent years, as builders and apartment developers have constructed high-end units to make the investment math work with some of the lowest interest rates on record. Cheap money’s other draw is the leverage afforded private equity to swarm the housing market in price-agnostic style pushing single-family rental rates to record highs.

In a September 2014 speech, Yellen worried that lower-income families had few assets to fall back on:

For many lower-income families without assets, the definition of a financial crisis is a month or two without a paycheck, or the advent of a sudden illness or some other unexpected expense. Families with assets to draw on are able to deal with these developments as bumps in the road. Families without these assets can end up, very suddenly, off the road.

But wouldn't it be difficult to build an asset base if the rent hikes far outpace income gains, which has been the case for many years?

Training the world’s largest economy to subsist on increasing levels of debt in exchange for less and less economic output is one legacy that has already been written.

The mammoth debt build that occurred during the Yellen years -- beginning when she ran the San Francisco Fed, ground zero for the subprime mortgage boom, and culminating with her tenure as chair of the Fed Board -- has indeed been historic. The seeds of the next financial crisis have no doubt been sown.

Yet, in June, Yellen was sanguine about the potential for another financial crisis: “I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.”

With the world’s central banks set to halve QE this year from record the $2 trillion pace of 2017, we can hope Yellen is right. The truth is we won’t know what the effect will be until the unwind occurs, the elixir of QE drip slows to a trickle, and the financial stability implications are revealed.

Or as Powell worried at the October 2012 FOMC meeting, “My concern is that for very modest benefits, we are piling up risks for the future and that it could become habit-forming.”

We will soon enough find out. We will then have the materials to properly assess the Yellen legacy.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Danielle DiMartino Booth, a former adviser to the president of the Dallas Fed, is the author of "Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America," and founder of Money Strong LLC.

To contact the author of this story: Danielle DiMartino Booth at Danielle@dimartinobooth.com.

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