With the government shutdown and debt ceiling debate pushed to the back burner for now, attention can once again return to headlines we were watching at the start of the fourth quarter. A big one is the Federal Reserve and the changes in policy we may see when President Obama’s newly-named nominee Janet Yellen steps into current Chairman Ben Bernanke’s shoes.
But first, Ms. Yellen has to go through confirmation hearings with Congress. But since she’s spent close to two decades working with the nation’s top government bankers in various positions of increasing visibility, prestige and responsibility, the odds of an undisclosed scandal wrecking her prospects are extremely slim. In fact, Goldman Sachs and other investment banks are already factoring four to eight years of her hand on monetary policy into their long-term economic models.
And while she’s been characterized as unusually soft on inflation, her track record is not going to give detractors much live ammunition to work with. Looking at past policy meeting transcripts, Yellen has been consistent at setting a firm line for how fast prices can rise. Her comfort zone has indicated that over the long term, any reading above 2% inflation on the CPI or 1.5% on the broader personal consumption expenditures (PCE) price index requires correction.
With consumer inflation currently drifting at a 12-month average of 1.7%, Goldman Sachs estimates that a Yellen Fed could have room to leave the federal funds rate down here at effectively zero through early 2016 before the price trend breaches the 2% comfort zone–much less crosses into more historically normal territory of 3% a year. And because this “central tendency” is public knowledge, if inflation gets out of hand, Yellen’s track record for staking out a position where the Fed can “react quickly and flexibly to change” almost demands a strong response in order for the Fed to retain any credibility in the markets at all.
For better or worse, much of Yellen’s more recent “dovish” reputation stems from her lobbying to cut interest rates faster than the rest of the Fed board, although now her warnings in late 2007 that the economy needed more fuel to avoid faltering arguably look more prescient than soft. As the liquidity floodgates opened mere weeks after that, the extra 25 basis points may not have made a difference either way.
Whether all that liquidity will eventually unleash pernicious 1980s-style inflation remains to be seen, but Janet Yellen may have a near-lock in any event on the job of winding the massive quantitative easing program down and finding the new normal for rate policy.