Argument

Crisis Management

Crisis Management

The U.S. government is careening towards what might be an epic financial implosion, and Washington is gripped in yet another frenzy of high-drama. By contrast, the nomination of Janet Yellen to be the next chair of the Federal Reserve is anything but dramatic, and certainly more calming to frayed financial market nerves than Larry Summers would have been.

Beyond the glass ceiling implications of Yellen being the first woman to serve in that post, however, what should we make of this coming transition?

The prominence of the Fed has grown enormously over the last decades, starting with Paul Volcker, accelerating with Alan Greenspan, and continuing with Ben Bernanke. Perhaps because the Fed is independent and separate from party interests, it has acted as a steward of the financial system, and such attitudes are rare in the world of partisan politics. Critics — and they are legion, vociferous, and mad as hell — believe that the Fed is burdened with arrogance and has made precisely the wrong long-term decisions in a desperate attempt to stave off the crises that are an inevitable and healthy part of a free-market system. The Fed bankers themselves believe that they have kept the proverbial lights on in the face of political malfeasance and waves of global change. Yellen will do nothing to heal that split, and given her background is likely to see it widen.

Yellen has served as the Federal Reserve’s vice-chairman since 2010, was a governor of the bank during the Clinton administration, served as Clinton’s chair of the Council of Economic Advisers, and began her career as a staff member of the bank’s research division in the 1970s. She worked her way through the ranks at the Fed, and would be the first head of the bank to have a resume largely built on serving that institution. She has impeccable academic credentials, with a Ph.D. in economics from Yale and a brief stint as a professor at Harvard. She is married to the Nobel Prize-winning economist George Akerlof, and has spent many years focused on employment, wages, and labor patterns.

Though she has accumulated respect within the worlds of academia and banking, she is not without critics — hardly surprising given a multi-decade career in the upper echelons of policymaking. Indeed, it would be more surprising if she had no critics. Some have questioned her managerial style, while others have praised it, making it all but impossible to parse unless you know her.

The most telling criticism came during her confirmation hearings to be vice-chair. Because she was president of the San Francisco Fed during the housing bubble, some senators, including Republican Richard Shelby of Alabama, questioned how she could have allowed such egregious lending standards and loose credit. Yet, as a recent story in Bloomberg noted, in 2007, she was one of the first inside voices on the committee to express serious concern that housing prices were overinflated and heading for a fall with serous ripple effects throughout the economy.

Assuming she is confirmed, and that seems to be an extremely safe assumption, she will face a situation every bit as unenviable as the one that confronted her predecessor Ben Bernanke when he took the job. The best response so far to her nomination came from a tweet by former Obama speechwriter Jon Lovett, who quipped, "We finally get a woman to chair the Fed and what happens? Bunch of men try to destroy the monetary system before she can even start the job."

Yellen would not assume the position until January 2014, and by then, the drama over the debt ceiling and levels of funding for the U.S. government will have been resolved, one way or another. It’s certainly in the realm of the conceivable that the morass over the debt will lead to sharply higher interest rates, and that would be an added item to an already full plate for Yellen. While she will likely not have to clean up the mess of a default or delay of U.S debt obligations, she will still confront an array of choices that revolve around when to taper Fed purchases of government bonds, how aggressive the bank should be as a lender last resort, and what to do if worst fears come to pass and the U.S government proves unable to prioritize payments in order to pay interests on its outstanding bonds.

Bernanke also was plunged into a crisis, and he responded with an aggressive policy of zero interest rates, easy access for banks to borrow from the Fed’s coffers, and quantitative easing that has seen the Fed purchase $85 billion of securities a month and its balance sheet expand to more than $3 trillion. Those moves have been forcefully supported by Yellen, and may even have been policies that originated with her (absent microphones and transcripts, which only the NSA could conceivably provide, we will never fully know). She will now bear the responsibility of unwinding those purchases, and while many fear the possible effects that will have on markets, rates, and the global flow of money, no one knows what the consequences will be.

The optimal outcome will be a gradual rebalancing of global accounts, done slowly and deliberately over the course of years. The problem is that reality does not always present policymakers with optimal conditions. The bank has been adept under Bernanke in responding to crises, as have the other major central banks around the world. That is not a statement without controversy. A considerable chorus believes that central banks have critically wounded the free market and only forestalled the inevitable crash and crisis borne of years of ill-advised government monetary and fiscal policies worldwide. Many investors believe that whatever strength there has been in equities and whatever calm there has been in global bond and financing markets is a product of deeply misguided Fed policies, and that we are nearing a break point.

The Tea Party certainly believes that, and prefers to get the implosion over with now rather than later. Better a crash triggered deliberately than one that sneaks up on you, they argue. Yellen would not agree. She strongly believes that monetary and fiscal policies need to be supportive of the weak American economy and lousy labor market. She will not gain any allies in the Tea Party caucus, nor will she likely be on the Pauls’ Christmas card list.

More than most Fed chairs, she is acutely sensitive to the labor market. Of course, one can question how much Fed policy can directly impact the labor market: The "dual mandate" of the Fed to promote "stable prices" and "maximum employment" only dates back to 1977, and the levers of money flow seem to have only an elliptical effect on whether companies hire. That flies in the face of macro-economic theory and policy, which holds that lack of credit or access to capital is one reason companies don’t hire and one reason they fire. But in a world of enhanced productivity generated by robotics and information technology, companies often choose to invest not in people but in software systems or robots. There ain’t much the Fed can do about such trends, nor would it prudent to try.

Yellen is the ultimate technocrat, and that is both a genuine strength and a possible weakness. The appeal of Larry Summers was that he was unpredictable and unbeholden to economic orthodoxies that he felt congenitally driven to question. But he lacked support and has a knack for making enemies. The world of macro-economic policy has become immensely complex, and technocratic knowledge is a necessity. Nonetheless, it is still a system of rules created by people. Economics and banking may be seen as a science, and economies perceived as mechanical systems in need of tuning and fixing, but in truth, they are fluid, ever-evolving systems that demand new responses to evolving circumstances. The Fed has acted creatively in recent years, and no one quite knows whether its policies will be a long-term success. The virtue of Yellen is that she shares responsibility for these innovative policies of quantitative easing. The unknown is whether she will be adept at how to alter that path if circumstances warrant.

Finally, in a world that is increasingly knit together by money, the Fed is a vital actor, but it is by no means the only actor or the most important. There is no one institution that shapes everything or most things. We live in a lattice of institutions where government has far less control, and where quasi-governmental institutions such as the Federal Reserve pull only a few select levers. Yellen may prove adept, or not, but her successes or failures will be one segment of a puzzle whose picture we don’t even know. She is today’s story and will be tomorrow’s Fed chair, but navigating the shoals of a morphing global economy will be left to all of us.