Federal Reserve Board Vice Chaiman Janet Yellen has been nominated to replace Chairman Benjamin Bernanke. Many observers support her selection by President Barrack Obama, in large part because she is not Lawrence Summers, the political minion of the disgraced former Goldman Sachs CEO, Treasury Secretary and Citigroup Chairman Robert Rubin. But before we start celebrating the choice of Yellen, it may be a good time to actually examine her views on inflation and economic growth.
Yellen is a neo-Keynesian of a decidedly left-wing variety who believes that using inflation to stimulate nominal growth is a valid policy choice. Her credentials on price stability are non-existent, in part because she believes, like many mainstream American economists, that it is possible to stimulate jobs by using monetary policy. The fact that such policies are destroying real consumer income and purchasing power does not seem to bother Yellen or a majority of the members of the Federal Open Market Committee.
Indeed, if you remember that Chairman Bernanke presently is the most conservative member of the FOMC, the choice of Yellen should alarm anyone who cares about inflation and the stability of real incomes and wages. James Grant, publisher or Grant’s Interest Rate Observer, believes that Yellen’s nomination will be a disaster for the Fed and the US economy. In a video comment on the “No on Yellen” web site, he makes the case for opposing Yellen’s nomination:
“Janet Yellen would be a perfect candidate for running the Post Office. She is energetic, dynamic, gets things done, terrific in meetings. She’d be wonderful; she’d balance the budget. As it is, she is up for the chairmanship of the Fed in which she would do enormous damage. What she wants to do is control interest rates. She would like to print money. She would like to manipulate markets in the service, she says, of advancing our fortunes. It can’t be done.”
The current policy consensus on the FOMC can best be described as one of short-term desperation. Prior to the subprime crisis and the ascension of Bernanke to be Fed Chairman, the FOMC relied upon the “Taylor Rule,” a formula developed by Stanford economist John Taylor. This supposed “rule” for guiding US monetary policy was the latest evolution of the neo-Keynesian socialism which has passed for serious economic thinking inside the Fed for more than half a century.
My friend and mentor Richard Alford, who worked with me years ago at the Federal Reserve Bank of New York, described the Taylor rule thusly:
“The problem is that the variables targeted by the Fed are exactly the same variables upon which politicians focus. Furthermore, in the construction of the Taylor Rule as applied by the Fed, the forecast horizon of policymakers and the lags inherent in monetary policy make the Fed’s policy horizon very similar to the political horizon… The existence of the Taylor Rule contributed to a Fed policy stance that made the housing and financial crises worse than they might have been — and was cheered every step of the way by the political incumbents of all stripes.”
With the subprime crisis, however, even the relative discipline of the Taylor Rule has been discarded by the Fed. Now the liberal economists on the FOMC have embraced an explicit policy of promoting inflation with no concern about future inflation. So far, these economists argue, there has been no inflation as a result – at least measured by official statistics. But ask any American family if their cost of living has declined in the past decade. In fact, inflation already is a serious problem measured by rising living costs and falling real incomes.
Milton Freidman wrote famously in “The Counter-Revolution in Monetary Theory” (1970):
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. … A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth. It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society.”
Janet Yellen represents the latest evolution of socialism and political expedience inside the Fed, a dangerous trend that essentially states that there is a positive trade-off between inflation and jobs. Under the Taylor Rule, Mark Thoma wrote in 2007, “output and employment stability expressed as maximizing household welfare, and the economic security that comes with it, is consistent with the a policy rule that places a lot of weight on inflation.” But the Fed’s record over the past five years suggests that this view is badly mistaken. Again Richard Alford:
“Maybe it is time for the Fed to disavow the Taylor Rule and simply admit that the US central bank has no cohesive intellectual framework for meeting its legal responsibilities to ensure full employment and price stability – other than political expedience.”
When members of the Senate consider the nomination of Janet Yellen to lead the Fed, they ought to ask her to defend her record as a member of the FOMC with respect to real inflation as it affects American workers and families. More important, they need to ask Yellen and other Fed officials to describe the policy framework now guiding US monetary policy and how this policy is consistent with both full employment and price stability. Looking at the Fed’s policy statements since 2007, there does not seem to be any rational basis for US monetary policy save wishful thinking.