Janet Yellen’s legacy: Her impact on the Fed, banking and economy

February 2, 2018 11:34 AM

WASHINGTON — As Janet Yellen steps down as chair of the Federal Reserve Board, she leaves behind important accomplishments and critical changes to the central bank, but the ultimate impact of her tenure is hard to predict.

Friday is Yellen's last business day as head of the Fed. One notable aspect of her time as chair is that it has been so short. She was only sworn in as Fed chair in February 2014 and is the only Fed chair not to have been reappointed since G. William Miller left the post in 1979. But her time atop the central bank has been eventful nonetheless.

Aside from being a trailblazer as the first woman to run the Fed, she inherited an entirely new and developing regulatory regime over large banks and nonbanks, guiding the agency in what were still early days of the post-crisis and post-Dodd-Frank Act period. She also inherited an economic landscape that was tenuously recovering from the downturn, and delicately steered it toward normalization in what were sometimes choppy macroeconomic conditions.

She set a course for the Federal Reserve to draw down its balance sheet after its historic experiment in quantitative easing, and in the process is leaving her successor, Fed Gov. Jerome Powell, with an even stronger economy than the one she inherited four years ago.

But regulatory questions still loom large upon her departure, particularly dealing with the right calibration of capital requirements for stress tests. There are also macroeconomic problems that she was unable to solve. Some observers say her approach to balance-sheet normalization has been too timid, while others say she did not take the implications of rising economic inequality as seriously as she should have.

What is Janet Yellen’s legacy? It is too early to say, and it depends on whom you ask. But here are some things that will certainly stand out.

Janet Yellen, chair of the U.S. Federal Reserve, speaks during a Senate Banking Committee hearing in Washington, D.C., U.S., on Thursday, July 13, 2017. Yellen said yesterday the U.S. economy should continue to expand over the next few years, allowing the central bank to keep raising interest rates, while also stressing a gradual approach to tightening as the Fed monitors too-low inflation. Photographer: Andrew Harrer/Bloomberg

Andrew Harrer/Bloomberg

WASHINGTON — As Janet Yellen steps down as chair of the Federal Reserve Board, she leaves behind important accomplishments and critical changes to the central bank, but the ultimate impact of her tenure is hard to predict.

Friday is Yellen's last business day as head of the Fed. One notable aspect of her time as chair is that it has been so short. She was only sworn in as Fed chair in February 2014 and is the only Fed chair not to have been reappointed since G. William Miller left the post in 1979. But her time atop the central bank has been eventful nonetheless.

Aside from being a trailblazer as the first woman to run the Fed, she inherited an entirely new and developing regulatory regime over large banks and nonbanks, guiding the agency in what were still early days of the post-crisis and post-Dodd-Frank Act period. She also inherited an economic landscape that was tenuously recovering from the downturn, and delicately steered it toward normalization in what were sometimes choppy macroeconomic conditions.

She set a course for the Federal Reserve to draw down its balance sheet after its historic experiment in quantitative easing, and in the process is leaving her successor, Fed Gov. Jerome Powell, with an even stronger economy than the one she inherited four years ago.

But regulatory questions still loom large upon her departure, particularly dealing with the right calibration of capital requirements for stress tests. There are also macroeconomic problems that she was unable to solve. Some observers say her approach to balance-sheet normalization has been too timid, while others say she did not take the implications of rising economic inequality as seriously as she should have.

What is Janet Yellen’s legacy? It is too early to say, and it depends on whom you ask. But here are some things that will certainly stand out.

A 'soft-spoken' trailblazer

Janet Yellen began her career after earning her Ph.D. in economics from Yale — she was the only woman in the school’s 1971 doctoral class — as a professor at Harvard, later joining the Fed board as an economist in 1977.

She bounced between academia, primarily the University of California at Berkeley, and the Fed system for much of the following decade.

When she was approached by the Clinton administration about joining the Fed’s Board of Governors in 1994, she credited her husband — the economist and Nobel laureate George Akerlof — with supporting her decision to take the post and advancing her career in public service.

“As I look back, I think that’s also been important to my career, his encouragement,” Yellen said in a November forum at New York University. “When I’ve been offered jobs in Washington, for example, his attitude has been, ‘You want to do that? Absolutely. We’re going to make it work.’”

She went on to chair the White House Council of Economic Advisors from 1997 to 1999, serve as the first female president of the Federal Reserve Bank of San Francisco from 2004 to 2010, serve as vice chair of the Fed board from 2010 to 2014, and as chair from 2014 until 2018.

Aaron Klein, policy director at the Center on Regulation and Markets at the Brookings Institution, said the variety of posts she has held within the Fed system is perhaps unrivaled, and her achievements — in a field with so few women in executive roles — render her almost peerless among economists.

“Yellen has reached the height of economic policymaking multiple times,” Klein said. “For anybody, that’s just an amazing, absolutely outstanding career. For a woman in her era, it was also trailblazing.”

Andrew Green, managing director of economic policy at the Center for American Progress, agreed that her achievement of being the first woman to head the Federal Reserve will undoubtedly be a central part of her legacy.

Although Yellen has been a relatively low-key Fed chair, the competency and authority she brought to the position were unquestionable, Green said.

“She’s a somewhat soft-spoken academic in style,” Green said. “She’s not a bombastic bomb-thrower, not prone to mysterious statements the way [former Fed Chair Alan] Greenspan was, or getting swept up into the fancy people of Davos and whatnot. She’s somebody who looked at the numbers and listened to people, and tried to do what’s right for the little guy and gal.”

Daniel Tarullo, governor of the U.S. Federal Reserve, speaks during an open meeting of the Board of Governors of the Federal Reserve with Janet Yellen, chairman of the Federal Reserve, in Washington, D.C., U.S., on Tuesday, Feb. 18, 2014. The Federal Reserve is set to vote on new standards for foreign banks that will require the biggest to hold more capital in the U.S., joining other countries in erecting walls around domestic financial systems. Photographer: Andrew Harrer/Bloomberg *** Local Caption *** Daniel Tarullo; Janet Yellen

Andrew Harrer/Bloomberg

Getting Dodd-Frank over the finish line

A critical aspect of Janet Yellen’s legacy is her overseeing the completion of the regulatory superstructure that went into place after the financial crisis.

Green at the Center for American Progress said that although Yellen only served as chair as the last few Dodd-Frank rules were being finalized — and much of that was more directly overseen by former Fed Gov. Daniel Tarullo — she still signed off on the rules and was responsible for defending them.

“One defining aspect of her legacy is a pretty thorough implementation of Dodd-Frank and financial reform,” Green said. “She certainly continued to see the implementation of the various aspects of Dodd-Frank. Obviously, Tarullo was the point person on that, but she was very forceful and clear about the economic importance of financial reform.”

Randall Kroszner, a former Fed governor and professor of economics at the University of Chicago, said that when he worked with her on the Federal Open Market Committee — she was president of the San Francisco Fed at the time, and he chaired the Fed’s committee on supervision — she was highly engaged with ongoing questions about the stability of the housing market and bank supervisory issues in her district.

“Obviously there were a lot of challenges in the housing market, particularly on the West Coast, and institutions like Washington Mutual and IndyMac that were facing challenges,” Kroszner said. “I worked closely with her in dealing with those institutions.”

Yellen herself said in a speech from the Jackson Hole monetary policy conference last August that she believed the progress made in shoring up capital and liquidity at the biggest banks, instituting stress tests and establishing resolution plans at the biggest banks would make the financial system more resilient for years to come. But she warned that regulators should never get complacent about the economy’s resilience.

“I expect that the evolution of the financial system in response to global economic forces, technology, and, yes, regulation will result sooner or later in the all-too-familiar risks of excessive optimism, leverage, and maturity transformation,” Yellen said. “We can never be sure that new crises will not occur, but if we keep this lesson fresh in our memories — along with the painful cost that was exacted by the recent crisis — and act accordingly, we have reason to hope that the financial system and economy will experience fewer crises and recover from any future crisis more quickly.”

In a string of enforcement actions issued Thursday, the Federal Reserve barred one former banker from the industry for misappropriating confidential supervisory information and fined three others for misappropriating internal bank records.

The debate over a key Fed tool continues

One advent of the financial crisis, albeit a less understood one, was Congress granting the Fed the power to pay interest on member banks’ reserves held with the Fed.

This power, known as "interest on excess reserves," has emerged as the Fed’s primary tool for implementing its short-term monetary policy targets. The FOMC sets a rate for payments on excess reserves at the lower bound, known as a “floor” system, as opposed to a “corridor” system, where the Fed manages rates by buying or selling securities on the open market.

Yellen has since supported paying interest on reserves as a long-term solution, saying in her November New York University appearance that without that tool, the Fed would have a very difficult time enacting its monetary policy targets.

“It is currently our key policy tool,” Yellen said. “We absolutely need it.”

George Selgin, senior fellow and director of the Center for Monetary and Financial Alternatives at the Cato Institute, said that the preservation of the floor system outside of a crisis setting is a policy that Yellen — and indeed, most Fed officials — have embraced. But it could be a mistake, he said.

Selgin said the large balance sheet — which makes the floor system as effective as it is — may have negative secondary effects, such as persistently slow inflation and sluggish reaction times between monetary policy actions and market results.

“The Fed seems inclined to stick to its post-emergency floor operating system,” Selgin said. “It’s a system where interest is paid on reserves at a high enough rate that, essentially, it is the Fed’s target rate, and adjusting that administered rate is the Fed’s way of changing monetary policy. That’ a new normal we could do without, in my opinion.”

Kroszner said the reason the Fed’s power to pay interest on reserves was so important was because without it, inflation would skyrocket as the recession receded and interest rates began to rise. When the Fed poured billions into banks’ reserve accounts by buying assets as part of the quantitative easing program, as soon as it raised rates under the old regime, the banks would be highly incentivized to lend those reserves out rapidly, potentially causing inflation to spike.

“We knew that we were going to have to provide a lot of liquidity to the system, and we wanted to make sure that we had a credible way to exit,” Kroszner said. “In the old days, as interest rates went up, and interest on reserves was zero, that gave really strong incentives for banks to lend that money out very quickly. In recoveries, we saw inflation move up more than the Fed would like … and the Fed didn’t have all the tools to be able to control the lending of these reserves that had been built up during the downturn.”

Interest on reserves instead has been able to keep inflation in check, Kroszner said. Indeed, inflation remains below the Fed’s 2% target.

“Many people were very critical of the Fed in its crisis response for taking actions that would lead to very high inflation,” Kroszner said. “Obviously, we’re a decade past the crisis, and inflation is below the 2% target.”

An illustration related to wealth disparities.

Aunt Spray/auntspray - stock.adobe.com

Could the Fed have done more on income inequality?

Karen Shaw Petrou, managing partner at Federal Financial Analytics, said that while Yellen is undoubtedly a trailblazer and a first-rate economist, one unfortunate and likely lasting part of her legacy has been the Fed’s unwillingness to grapple with rising economic inequality in the United States over the course of the recovery.

“I think she will be remembered very favorably, in part because she was such a trailblazer, but I think the signal failing under her tenure was the increase in U.S. economic inequality,” Petrou said. “That is certainly not all her fault, nor that of the Fed. But unconventional monetary policy has a significant and demonstrable role in making economic inequality worse, and I do hold the Fed responsible for blaming the problem on everyone else.”

Yellen has said on many occasions that she worries about the lack of economic benefit that the post-crisis recovery is bringing to low-income Americans. During her semiannual testimony before the House Financial Services Committee in July, she said there is a valid complaint from the most disadvantaged citizens that the economic system is not working for them.

“I am very concerned about inequality in income and wealth,” Yellen said. “I think Americans need to feel that this ... economic system is one where rewards come to those who work hard and play by the rules, and when some groups do disproportionately well and others seem to be lagging behind, as has been the case, there's a sense of it being a very unfair system.”

Kroszner, who served with Yellen on the Federal Open Market Committee as a Fed governor from 2006 to 2009, said history will decide whether the policy of extraordinary monetary policy accommodation and quantitative easing — begun by Yellen's predecessor, Ben Bernanke — was correct, not only with respect to addressing economic inequality but also saving the overall financial system from protracted distress.

Recessions tend to hit people with the lowest incomes and the most unstable employment, he said. A slower recession, by extension, would have harmed those same people the most — perhaps even more than economic inequality is harming them now.

“What’s the alternative?” Kroszner said. “So let’s say that Fed did not keep rates low for as long, so monetary policy would have been tighter. Most likely, we would have had an even more gradual recovery. Having a more rapid recovery than might otherwise [have] been the case disproportionately helps people to get jobs and be reemployed on the lower end of the income spectrum. That has to be taken into account.”

Green said there is a fundamental problem with the argument that the Fed is responsible for income inequality: There is only so much that the Fed can do, and further attempts to address inequality could have other consequences. Raising or lowering interest rates has wide-ranging effects for the whole economy, he said, and the Fed has to weigh all of those effects.

“The Fed has a mandate to get people into jobs, and they only have so many tools,” he said.

Janet Yellen, chair of the U.S. Federal Reserve, arrives to a Joint Economic Committee hearing in Washington, D.C., U.S., on Wednesday, Nov. 29, 2017. Yellen, in what may be her last appearance before Congress as head of the central bank, described a steadily brightening picture for the U.S. economy while downplaying the risks of financial instability. Photographer: Andrew Harrer/Bloomberg

Andrew Harrer/Bloomberg

A 'return to normalcy' that wasn't easy

Klein at the Brookings Institution said that the legacies of Fed chairs — which can only truly be appraised from a distance — tend to be encapsulated in a single achievement or in the economic conditions over which they preside. In this vein, he said, Yellen will be remembered for having turned the Fed’s approach to the economy from one of tentative recovery to a more robust and sturdy economic expansion.

“Volcker slayed inflation, Greenspan presided over deregulation and the building of the bubble, Bernanke inherited the collapse and prevented a second Great Depression,” Klein said, referring to former Fed Chair Paul Volcker. “Yellen led the return to normalcy in providing, laying the foundation for a long recovery — hopefully a more sound foundation.”

Kroszner said that the extraordinary measures that Bernanke undertook to prevent the economy from an even more protracted recession posed a challenge that no one had successfully met before, which is to raise rates and unwind the Fed’s balance sheet without roiling markets and risking the need for a renewal of accommodative policy.

Through her deft forward guidance and telegraphing to markets that the accommodation would lift gradually and predictably, he said, she not only strengthened the recovery but provided something of a model for other countries facing a similar predicament.

“I think Janet will be remembered for the first steps toward exit,” Kroszner said. “Because she handled it so well, it seems easy. It wasn’t easy. It was unprecedented. She succeeded in making the unwind as exciting as watching paint dry.”

Fed Chair-designate Jerome Powell with President Trump

Jerome Powell, governor of the U.S. Federal Reserve and President Donald Trump's nominee as chairman of the Federal Reserve, speaks as Trump, left, listens during a nomination announcement in the Rose Garden of the White House in Washington, D.C., U.S., on Thursday, Nov. 2, 2017. If approved by the Senate, the 64-year-old former Carlyle Group LP managing director and ex-Treasury undersecretary would succeed Fed Chair Janet Yellen. Photographer: Andrew Harrer/Bloomberg

Andrew Harrer/Bloomberg

Should Yellen have been reappointed?

One question that will continue be asked about Yellen's legacy is whether she should have been reappointed as Fed chair by President Trump.

Trump was critical of Yellen while a candidate for president, but had mostly positive things to say about her once he was elected, which Kroszner said suggests that once he met her, he was convinced of her ability and value as a Fed chair.

“During the campaign, of course, the president was critical of Janet Yellen and of the Fed. But once he became president, he had only praise for Janet,” Kroszner, the former Fed governor, said. “I think it is because he got to know Janet and understand … her seriousness, her intelligence, and he very seriously considered reappointing her.”

Selgin at the Cato Institute said Yellen's single term and Powell’s nomination in her place was really the side effect of the two central bankers being so similar on monetary policy issues. In some ways, the choice not to reappoint Yellen may be remembered as a triumph of partisan politics, he said.

“There’s an overwhelming tendency when you have a sitting Fed chair and ... there isn’t a deep dissatisfaction with the incumbent to keep them as long as you can,” Selgin said. “The only reason Trump didn’t do that is because he had ready at hand a candidate who would allow him to satisfy his Republican constituency without rattling markets. It’s a very unusual situation where you can have your cake and eat it too.”

But the fact that Yellen ultimately did not get reappointed presents an opportunity lost, Petrou said, because she seemed to have the capacity to own her mistakes and endeavor to make them right.

“She, within the institution of the Fed, was a strong voice that was able to change,” Petrou said. “I hoped that with the luxury of what appeared to be a bit of a recovery, she would work harder at where it wasn’t as it should be and take effective action to make changes.”

Kroszner said that, ultimately, Yellen's strong performance as Fed chair will be remembered because of how difficult a choice it was for her not to be reappointed, and the fact that one of Powell’s main qualifications was that he was a advocate of her policies.

“I think, in some sense, although the president did not choose to reappoint Janet, I think by picking [Powell] he was effectively reappointing her policies,” Kroszner said.