Larry Summers’s withdrawal from consideration, turned Janet Yellen, in my view, from being a close second to clearly best candidate to Chair the Federal Reserve.
I have watched her from a distance since she left the corner office next to mine at the Berkeley Economics department and moved across San Francisco Bay to become president of the Federal Reserve Bank of San Francisco in 2004 – and she has shown a better understanding of the state of the economy and the impact of economic policies than most of her peers at the Fed.
I saw her worry more than other senior Fed policy makers that the housing market was undergoing not rational upward price adjustment or “froth” in the 2000s, but a bubble. I also saw her warn that deflation of the housing market might be rapid and dangerous.
I have noted Ms Yellen point out that the fact the presidents of banks such as Bear Stearns and its ilk bet their own fortunes on the proposition that they understood and controlled their derivatives books did not mean that they, in fact, understood and controlled their derivatives books.
I have observed her impress upon people that the time to worry about and guard against “moral hazard” in finance comes during the boom and the bubble, not during the crash and depression. I have seen her aggressively promote urgent and extraordinary measures to avoid the collapse of the financial system.
I have watched her urge people to read the works by Erica Groshen, now Commissioner of the Bureau of Labor Statistics, reporting that shifts in the US jobs market mean a big downturn is no longer guaranteed to be followed by a rapid employment bounceback.
She helped steer the Federal Open Market Committee from its late-2009 confidence that monetary policy could be rapidly normalised to its current posture that extraordinary monetary accommodation is likely to be required for years. That is no mean record – and it is all on the record – on which to build a candidacy.
But, in truth, that understates her record of insight. When I first saw Ms Yellen up close and in action, it was late-1988. She was a professor at Berkeley and taught me something important, something that I had not previously known and would not have thought of on my own. In a conference room at the Brookings Institution, she explained just how the welfare benefits of lowering unemployment were of much greater value than the mere boost in production it brings. For example, it also means fewer people in the wrong type of job.
When I next saw Ms Yellen up close and in action, it was the mid-1990s, and she had been appointed a governor of the Fed by Bill Clinton, then president. She was not in the business of showing she was the smartest person in the room. But she was in the business of making sure that the person in the room who had the most constructive thing to say got the floor. And she did know how to keep in check those who were trying to show they were the smartest person in the room whenever they grew attached to ideas because they were clever rather than because they were true.
Those of us on the Treasury and the Council of Economic Advisers staff who had recommended that Mr Clinton recruit her to the Fed were very pleased. We had been worried that the culture of the central bank – where staff deferred to division directors, division directors sought to please the chair and governors largely stayed out of the loop – was not the healthiest of environments for encouraging sound debate. Ms Yellen (along with some others selected by Mr Clinton) helped to open the place up.
Ideally, I would ask for more. I am in the faction of economists who think that what the Fed needs now is a regime change like the one that Paul Volcker imposed in 1979 as he launched the very painful breaking of the stagflation of the 1970s. It needs some of the bold leadership that President Franklin Roosevelt launched in the US in the 1930s and that Prime Minister Shinzo Abe is pushing in Japan right now. Ms Yellen is, to my taste, a little overinvested in the proposition that the Fed’s current policy consensus is the appropriate policy.
When the two leading candidates were Ms Yellen and Mr Summers, everyone who was not crazy knew that the policy stakes were small: the two have very similar views of the economy and were likely to follow very similar policies. Now the policy stakes are actually significant – and a substantial chunk of America’s future prosperity may well ride on the outcome.
(Lightly edited from a mid-September piece in the Financial Times)