Janet Yellen’s greatest mistakes will haunt her toughest job yet

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When Janet Yellen became chair of the Council of Economic Advisers in 1997, her husband, economic Nobel laureate George Akerlof, took full leave from his tenured post in Berkeley University’s economics department to support her career. Though he had taken over “household duties” when Yellen was named to the Federal Reserve’s Board of Governors several years earlier, he felt his role in “providing psychological support in the daily political storms was yet more important” during her White House tenure, he wrote in his biography for the Nobel prize.

Time to dust off those psychological support skills. Yellen, with her warm smile and demure stature, returns to the White House as Treasury Secretary amid a political and economic firestorm that is infinitely more complex than the one she took on nearly three decades ago. As a former Fed chair and White House policy adviser, the country’s two other highest-ranking economic policy positions, she is arguably the most qualified person ever to take on her new role.

And yet the stakes could not be higher.  “We are living in a K-shaped economy, one where wealth built upon wealth, while working families fell farther and farther behind,” Yellen said during her confirmation hearing last week. “We have to rebuild our economy so that it creates more prosperity, for more people, and ensures that American workers can compete in an increasingly competitive global economy.”

In charting the right path, Yellen must calibrate her course of action against a wildly uncertain future: In the coming months, global growth could either nose-dive if the pandemic worsens or bounce back if vaccines are effective and distributed efficiently. She is well-versed in navigating uncertainty, after managing the Fed’s unprecedented purchase of trillions of dollars in assets to shore up the economy after the 2009 financial crisis. 

But she is also deeply aware of the repercussions of even the slightest misstep—for instance, of raising interest rates too early, as many believe she did in 2015 as Fed chair, or too late. Yellen’s greatest challenge will be to respond to the moment with the steadiness that has served her career well, without letting fear of miscalculation cloud her judgment.

What Yellen believes

Yellen takes control of the country’s purse strings during a time of intense debate about the best way to remedy the faltering economy. The job losses caused by the pandemic’s economic crisis are quadruple those experienced during the 2009 crisis, when Yellen was vice-chair of the Fed. To respond effectively, she must woo a split Congress that is caught between negotiating a multi-trillion-dollar economic recovery package and a highly contentious impeachment trial. She will also become chief arbiter of the dizzying debate amongst economists over how much more the government can spend than previously thought without stoking inflation.

It’s territory she knows well. Yellen, a deeply studious left-of-center economist, has long believed that the central bank and government should use monetary and fiscal policy to temper the market’s ups and downs for both Wall Street and main street’s benefit. Her dovish leanings trace back to her PhD studies at Yale under Nobel-prize-winning economists Joseph Stiglitz and James Tobin, who followed the work of John Maynard Keynes in advocating that economics should be, as Yellen has put it, “about caring for real people.” She embraced Tobin’s approach so instinctively that he rolled her class notes into his teachings as a reference for other students, a fact that former classmates like economist Kenneth Rogoff and former Treasury Under Secretary Jeffrey Shafer recall fondly.

Stiglitz and her husband Akerlof helped cultivate Yellen’s conviction that human emotion is central to how markets function. In one of her most cited academic works, she and Akerlof asked why an oversupply of labor doesn’t always lead firms to cut wages to an “efficient” market rate. The paper was inspired by the couple’s real-world experience of hiring their first nanny, she told TIME during her stint as Fed chair. “When you hire a nanny, the question you ask yourself is, ‘What’s best for my precious child?’” Yellen explained. “And do you really want someone who feels that your motive in life is to minimize the amount you spend on your child?” The humane view was a break from the longstanding assumption in economic theory that economic actors make purely rational decisions. 

Yellen’s willingness to challenge conventional wisdom prevailed as she entered the policy world. As a member of the Fed’s Board of Governors in the late 1990s, she pushed former Fed chair Alan Greenspan to raise interest rates to guard against inflation, a move he long resisted and later regretted. Yellen was also the first of the Fed’s 19 policymakers to sound alarm bells about the looming subprime mortgage crisis that spiraled into financial calamity. As vice-chair of the Fed she then ushered in the unconventional quantitative easing program intended to resuscitate the economy by encouraging spending and job creation.

As Fed chair she continued her relentless focus on jobs, creating a dashboard of indicators beyond just the unemployment rate to keep better tabs on the health of the workforce. And unlike her predecessors, she spoke often about the perils of inequality and the lasting damage to American households of high unemployment.

What Yellen worries about

And yet, this line of thought—that monetary policy can bolster the fortunes of not just the rich, but of regular Americans in times of crisis—has come to haunt Yellen and other economists who worry that Fed policy has made inequality worse by pushing up asset prices of wealthier households invested in the markets, while leaving the uninvested behind.

While some Fed leaders praised Yellen during her time as Fed chair from 2014 to 2018 for bringing down the unemployment rate to roughly 4%, others worried that the long run of unconventional monetary easing would overheat the economy and stoke inflation. And so in 2015, as the economic recovery was gaining speed, Yellen raised interest rates from near zero in a move that critics deemed too early, which rattled financial markets and slowed the economic recovery. Yellen continued to defend the move, but she would later lament that wages had only risen modestly while inflation had remained too low in the years following. “I want to see it move up to 2%,” she said in her final Fed news conference in 2017. “There’s work undone there.”

Yellen’s experience set the stage for her successor at the Fed, Jerome Powell, to adjust the Fed’s approach to its dual mandate of maximizing employment and stabilizing prices. Despite decades of rising government debt and falling interest rates, inflation had not ticked up to worrisome levels. By the summer of 2020, as the pandemic took its toll on the economy and jobs, the Fed made a move known in policy circles as “Powell’s pivot”: Powell announced that unemployment could go lower than Fed leaders had understood without sparking inflation. “Our view [is] that a robust job market can be sustained without causing an outbreak of inflation,” he explained to a gathering of central bankers in Jackson Hole, Wyoming. “Our policy framework must adapt to meet the new challenges that arise.”

Powell also pressed for more fiscal stimulus, stressing that the Fed’s tools couldn’t adequately target the growing problem of inequality during the crisis. “There are better tools held by elected officials” to address long-standing gaps. “We’re going to keep doing what we can do. We really need it to be broader than just the Fed.”

How Yellen thinks about inflation

Yellen agrees. For months, she has stressed the need to pass more government relief while interest rates are low, especially to help low-income workers who risk permanent job loss. “This is not a good time to have fiscal policy switch from being accommodative to creating a drag,” Yellen said in a September interview with The Wall Street Journal. “That’s what happened [last decade], and it retarded the recovery.” 

Proponents of this thinking point to evidence that government borrowing costs have not risen in line with higher budget deficits. In fact, borrowing costs were higher in the late 1990s when the government ran surpluses than when deficits later ballooned. 

She will have to square that thinking with Congressional budget hawks and investors who think adding to the government’s $26.7 trillion debt load could trigger inflation at any time. 

Yellen is not immune to the threat of inflation, nor does her thinking appear to have dramatically changed during the latest stretch of ultra-low inflation. In recent years, she has advocated to raise taxes and cut spending on Social Security and Medicaid to rein in the country’s “unsustainable” debt path. “We’re not living within our means right now. Debt is going to escalate, and that’s going to create problems down the road,” she told a senior housing trade group in 2019.

Yellen has also denounced a widely-popularized theory circulating among progressive economists that because the US government controls its own currency, it need not be constrained by its debt or deficits in how it spends. The idea behind modern monetary theory, that “you don’t have to worry about interest-rate payments because the central bank can buy the debt,” Yellen said at a 2019 investor conference in Hong Kong, is a “very wrong-minded theory because that’s how you get hyper-inflation.” Her willingness to spend big in the near-term stems from her understanding of “how distinct this time is for the labor market, particularly for the lowest-wage workers out there,” economist Diane Swonk told the Washington Post.

The question is one of degree. If Yellen is successful in her mission to shore up jobs without courting inflation, she will face a political dilemma a few years down the road: whether to stick to her convictions and push for the painful spending cuts politicians and voters abhor, or arrive at new thinking that continues to kick the can down the road.