What does the future hold for Yellen's Fed?

As Janet Yellen prepares for her promotion to head of the US Federal reserve in January from her current position as vice-chair, the issue of quantitative easing (QE) and its eventual tapering will be foremost in the minds of many observers.

Some of her views on the tapering of QE are already public. For instance, she is a staunch defender of the Fed’s dual mandate to target inflation and unemployment. She is also an advocate of transparency and openness in communicating the central bank’s plans.

These two interests converged in January 2012, when she became the driving force in the Federal Open Market Committee (FOMC) behind the Fed, publicly linking its guidance on monetary policy to a long-term inflation goal of 2% and a long-term unemployment rate between 5.2% and 6%. The FOMC described these thresholds as consistent with the objectives of the Fed’s dual mandate and pledged to pursue them in a balanced way.

With these guidelines in mind, Ms Yellen, in a speech in Washington, DC, in April when US unemployment was still running at 7.7% (it is now 7.3%), declared: “With unemployment so far from its longer-run normal level, I believe progress in reducing unemployment should take centre stage for the FOMC, even if maintaining that progress might result in inflation slightly and temporarily exceeding 2%.”

Toeing the line

For this remark and her affiliation to the Democratic Party, Ms Yellen has been described as dovish on monetary policy by Republicans, although according to one Washington-based economist, in 42 of her speeches she very closely toes the Fed’s traditional tough line on inflation.

Moreover, in spite of the Fed’s unprecedented monetary stimulus, which combines the holding of short-term interest rates to near zero with unconventional measures, such as massive purchases of long-term government assets, the US economic recovery has faced considerable headwinds. Risk-averse banks have not been lending much. Debt-constrained consumers have not been borrowing much. And fiscal policy has been tight since Republicans won control of the Lower House in 2010.

In line with her dovish reputation, Ms Yellen, in brief comments after US president Barack Obama nominated her to succeed Ben Bernanke as head of the Fed, suggested she was in no hurry to wind down QE. “Too many Americans still can’t find a job, and worry how they will pay their bills and provide for their family,” she said in a statement.

Striking a different note

On the other hand, at a meeting of the International Monetary Fund (IMF) earlier this year, she struck a different note. “Some have asked whether the extraordinary accommodation being provided in response to the financial crisis may itself tend to generate new financial stability risks... The Federal Reserve continues to carefully monitor this situation,” she said.

Similarly she is aware of the need for clear communication when it comes to decisions about tapering. “At some point it will be appropriate to begin the process of withdrawing the significant [Fed] accommodation,” she said in a speech in Washington in April. “I believe, once again, communication will play a central role in managing this transition.”

William Powell, a Fed governor, said at a gathering of bankers at the IMF annual meetings in October that “the path for asset purchases remains entirely data-dependent”. Likewise, Ms Yellen’s responses to economic problems and monetary issues invariably have been data-driven, grounded in fact and analysis, and subject to change as the facts change.

Accepting her nomination for the role of head of the Fed, she said: “The Fed has powerful tools to influence the economy and the financial system. But I believe its greatest strength lies in its power to approach important decisions with expertise and objectivity.”

Meanwhile, it will also come under her watch as Fed chair to implement the regulations the central bank has been given under the Dodd-Frank Act to make the banking sector safer. Her views, according to a speech in Shanghai in June at an international monetary conference, are that she wants big banks to hold more capital than that determined by Basel III to make them more resilient to shocks.

Ms Yellen also wants to establish minimum margin requirements on derivatives trades to make the financial system less vulnerable to contagion should a bank collapse. She said: “We need to increase the transparency of shadow banking markets... The global regulatory community should focus significant amounts of energy now to attack this problem.”