Yellen: More humming-bird than dove

The markets are a little worried about this well-written recent piece about Fed Chair Janet Yellen In the New Yorker. This extract (below) in particular is leading some to wonder whether she will be dangerously dovish and overcommitted to fighting unemployment, and will eventually cause a huge inflationary meltdown.

The more constrained Yellen’s world becomes, the more her instinct will be to return to the distilled essence of herself, the unrepentant Keynesian; the pressure to demonstrate hawkish capabilities comes from without, and the Keynesian inclinations from within. “You can’t think about what is happening in the economy constructively, from a policy standpoint, unless you have some theoretical paradigm in mind,” she told me. Alan Blinder told me that, in the mid-nineteen-nineties, when he and Yellen were both Fed governors and felt they might have momentarily pushed Greenspan into a more dovish position, one of them said to the other, “I think we might have just saved five hundred thousand jobs.” He went on, “We felt pretty good about that. . . . Now she can raise her sights—one million jobs. Two million.”

More and more people are getting uneasy about comparisons to the 1970s. Back then, the Fed misjudged slack in the economy, and dealt poorly with the oil shocks. Inflation got embedded and it took the vicious 1980-1982 recession to restore stability. Being lax about inflation eventually caused the worst unemployment in decades. Is the Fed doing the same thing again, adding a few more shots of tequila to the punch at the party just when everyone needs to sober up and get ready to drive home?

I’d draw a different conclusion from some of the color in the article, however, which matches my own impressions of her. She’s “cautious”, “over prepared”, the “reality” person compared to her much more fiercely partisan husband. She doesn’t like to go out on a limb with extreme positions, such as the incident where she didn’t say much during the big Born/Summers confrontation mentioned in the article. She makes a point of trying to summarize other people’s views at meetings.

In other words, she has a definite point of view, but she ISN’T a flaming ideological partisan firebrand. She is temperamentally pragmatic. Her main Keynesian vice is believing a little too much in aggregate demand as the be-all and end-all. But that is self-correcting given signs of inflation. She is emphasizing unemployment right now because she thinks there is essentially no inflation threat.

Journalists can overemphasize the relevance of academic debates to practical policymaking, because conflict makes for a good story. (Instead, it ‘s usually the unexamined assumptions that everyone agrees about about that cause the most trouble.)

In fact, as I noted here, policy is more incremental in practice. It is made by “muddling through” with tiny adjustments every six weeks, not arguing about questions of ultimate theoretical principle in seminar-room style. Consider: The difference in the Committee’s projected “dots” for timing of raising interest rates is not nearly as large as theoretical differences about economic models.

In fact, it’s likely that Yellen will eventually surprise the markets by flipping towards a focus on inflation more dramatically than expected.

The bigger danger – and this is where the hawks on the FOMC have a legitimate point – is that she will be too activist and overconfident, and will unintentionally cause problems by being too ambitious about what policy can achieve.

First do no harm

The New Yorker article discusses how new classical economists came to believe that monetary policy could achieve little if anything at all. Only Plosser has some sympathy for that extreme view in the committee. All the others think that the Fed can contribute significantly to the economy.

But many acknowledge that the Fed can also make serious mistakesas happened in the 1970s. It quite easy to make the swings and oscillations in the economy even worse. It’s like pushing a kid on a swing. If you give an extra shove when they are at the top of the cycle, you can make the swings even more hair-raising. That produces squeals of delight in children. . but disaster in economic cycles.

The Fed is still giving the largest shove in recorded history to the economy, as QE slowly tapers and nominal interest rates remain at effectively zero, And it is very difficult to get the timing of shoves right. It is typical for economists to be unsure whether the economy has emerged from recession for six months or longer. Data has a habit of getting revised in ways that massively changes the picture of the current economy. Lags are notoriously “long and variable.” For years central bankers has an instinctive distrust of trying to “fine tune” the economy with too much precision as a result.

It’s not the goal of monetary policy, hawk or dove, which is the risk with Yellen. She’s not chained to a dove’s perch. Instead, she’s more likely to be like a humming bird, in frenetic motion. The blur of flapping wings is the risk.

For central bankers, it’s usually better to me like an eagle, hardly twitching a muscle, patiently watching and floating high above the fray below, and then striking at just the right moment.