Janet Yellen looks to be taking one page out of Alan Greenspan’s playbook while tearing up another as she plots monetary strategy for 2015 and beyond.
The Federal Reserve chair and her colleagues signaled this month they would be willing to push unemployment below its so-called natural rate, a feat Greenspan as chairman managed in the late 1990s without fanning much inflation. Yellen showed less desire to pursue her predecessor’s “measured” approach to raising interest rates in the mid-2000s, suggesting his strategy may have fostered complacency that made a small contribution to the financial crisis.
The late 1990s “was a very good period for the U.S. economy, and Greenspan made the correct call on monetary policy,” said Michael Gapen, a former Fed official who is now senior U.S. economist for Barclays Capital Inc. in New York. On the other hand, “there is a general consensus the way they did policy wasn’t right” in the run-up to the housing bust that preceded the 2007-2009 recession.
Yellen stressed to reporters on Sept. 17 that the Fed’s actions would depend on how the economy evolves. “There is no mechanical” approach to carrying out policy, she said, adding that “many people” think the Fed relied too much on a lock- step strategy in the mid-2000s.
James Bullard, St. Louis Fed president, is among those who argue that approach led to complacency about the Fed’s intentions and too much risk-taking by investors and home buyers.
“The 2004 to 2006 tightening cycle was way too mechanical,” he said Sept. 23. “There was so much predictability there that I think it did foster asset-price bubbles.”
Yellen’s strategy has its risks. A persistently easy monetary policy designed to push unemployment down could unleash unexpectedly strong wage and price pressures, leading to what former Fed Governor Laurence Meyer called the “nightmare” scenario of rising inflation expectations. It could also lead to distortions in financial markets, even without adoption of Greenspan’s lock-step rate increases, a danger some Fed officials warned about in a paper this month.
The Federal Open Market Committee this month stuck with a pledge to hold interest rates near zero for a “considerable time” after it ends asset purchases, probably in October. It also indicated it would take its time in raising rates further once it began tightening credit.
Policy makers made clear their intention to test how far they can lower unemployment in economic projections they released on Sept. 17. They see a jobless rate of 4.9 percent to 5.3 percent in late 2017. That’s below the 5.2 percent to 5.5 percent rate they say is a level that won’t heat up inflation, the so-called non-accelerating inflation rate of unemployment, or NAIRU. That’s often called the natural unemployment rate. Joblessness was 6.1 percent in August.
William C. Dudley, New York Fed president, drew attention to the central bank’s aims in a Sept. 22 interview. Rather than expressing concern that pushing unemployment below its natural level would lead to dangerous price pressures, Dudley argued it might be necessary to raise inflation to the Fed’s 2 percent target. As measured by the personal consumption expenditure price index, inflation was 1.6 percent in July and has been below the central bank’s goal for more than two years.
“We really need the economy to run a little hot for at least some period of time to actually push inflation back up to our objective,” Dudley said in the interview.
Greenspan countenanced a drop in the unemployment rate to a 30-year low of 3.8 percent in April 2000 as he probed how hot the economy could run without triggering too much inflation. His effort was made easier by a technology-led surge in productivity, enabling companies to pay workers more without having to raise prices.
“It allowed the Fed to push unemployment well below its estimate of NAIRU,” said Meyer, who is now senior managing director of Macroeconomic Advisers in Washington.
Yellen probably can’t count on that this time. Business output per hour worked, excluding agriculture, has risen at a 1.3 percent average annual rate since the recession ended in June 2009, less than half of the 2.9 percent pace from 1996 to 2000, according to Labor Department data.
The Fed chair, though, has other things going for her. She argues there’s more slack in the labor market, and thus less inflation risk, than the unemployment rate alone suggests. She points to the 7.3 million Americans working part time who want a full-time job and the depressed labor-force participation rate, which is stuck at a 36-year low.
Slow growth overseas and a rising dollar, meanwhile, are helping cap price pressures in the U.S., Gapen said. Import prices in August fell 0.4 percent from a year earlier, according to the Labor Department.
“There may be global disinflationary trends,” Gapen said.
Even if the Fed manages to keep inflation under control as it pursues a lower jobless rate, the central bank could still risk stoking dangerous asset bubbles by keeping monetary policy loose. That was the message of a paper released by two top Fed researchers Sept. 2.
Accommodative monetary policy may “contribute to the buildup of financial vulnerabilities and hence increase risks to financial stability,” wrote Tobias Adrian, an economist at the New York Fed, and Nellie Liang, director of the Fed’s Office of Financial Stability Policy and Research in Washington.
Dudley said there has been a “sea change” in the way the Fed thinks about asset bubbles since Greenspan’s tenure. Under Greenspan, policy makers thought bubbles were “very hard” to spot beforehand. So they decided to wait until they burst and “clean up after the fact,” he said.
“That didn’t work out so well in the financial crisis,” he said. Now officials “try to identify asset bubbles in real time” and “see what tools you have” to address them.
In what JPMorgan Chase & Co. economist Michael Feroli said was probably a nod to such concerns, Yellen suggested to reporters on Sept. 17 that she wouldn’t emulate Greenspan’s methodical approach to raising interest rates.
The Greenspan-led Fed began tightening credit in June 2004, bumping up the federal funds rate by a quarter percentage point while saying it expected further increases to be “measured.” The central bank then raised rates in 25-basis-point increments for 16 straight meetings.
Greenspan has conceded that he was wrong in opposing more oversight of the financial markets in the run-up to the crisis. He has, though, rejected arguments that an overly loose monetary policy helped fuel the housing bubble that eventually burst.
“There is no evidence that the actual price levels of homes was significantly affected by the action which we took,” Greenspan said on CNBC last December.
As president of the San Francisco Fed, Yellen took part in discussions about the central bank’s strategy in 2004 and 2005 and was generally supportive of it, according to meeting transcripts, though she wasn’t a voting member of the FOMC at that time.
She did back four quarter-point increases in the funds rate once she got a vote in 2006, three of which came after Ben S. Bernanke succeeded Greenspan in February of that year. None of those decisions included a pledge for “measured” increases, language the FOMC dropped after December 2005, partly at Yellen’s instigation.
“Looking back on the period, the run-up to the financial crisis, I don’t think by any means ‘measured pace’ and the very predictable pace of 25 basis points per meeting explains why we had a financial crisis, but it may have diminished volatility and been a small contributing factor,” Yellen said Sept. 17.
Policy makers will face a tough task abandoning such language while trying to reassure investors that rates will be raised slowly as the Fed tests how far joblessness can fall, said Richard Clarida, executive vice president of Newport Beach, California-based Pacific Investment Management Co., which manages $1.97 trillion.
“They are going to be trying to thread a needle,” he said. “They’re going to want a gradual pace of rate hikes but don’t want people to get too relaxed, like they did with measured pace.
‘‘Good luck with that.”
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