During his State of the Union speech, on Tuesday night, Donald Trump took credit for the country’s strong rate of job creation, its rising wages, and the lowest unemployment rate in many years. Meanwhile, Janet Yellen, the person primarily responsible for these things, was preparing to leave her post as the chair of the Federal Reserve Board. On Wednesday, she chaired her final meeting of the central bank’s policy-making arm, and Friday will be her last day at the Fed. On Monday morning, Jay Powell—a Republican, investment banker, and current member of the Fed’s board—will be sworn in as her successor. In a more just world, Yellen would have been given a second four-year term, as most of her (male) predecessors were. But late last year Trump decided to replace her with Powell.
Having spent fourteen years at the Fed, and having been the first woman to lead it in its hundred-and-five-year history, Yellen is leaving with a record of high achievement. A fiercely smart academic economist—she holds a Ph.D. from Yale—she served as a loyal and able deputy to her predecessor at the Fed, Ben Bernanke. Upon taking the top job, she quickly demonstrated a mastery of the communicative and political skills that are necessary to run a large institution like the Fed. In speeches and at press conferences, she explained the Fed’s thinking clearly and carefully, doing her best not to lapse into the technical jargon beloved by economists. Her colleagues liked and respected her, and she charmed some key Republicans on Capitol Hill. (That helped to head off recent calls, emanating from some corners of the G.O.P., for an inquisitional audit of the Fed.)
She even got along well with Trump, a fellow New York native. (Yellen grew up in Brooklyn.) Last November, when he announced that he would nominate Powell rather than keep Yellen for a second term, he said, “She’s a wonderful woman who’s done a terrific job.” This statement raised the question of why he didn’t leave Yellen in place. It was widely assumed that partisan politics were responsible: Yellen is a Democrat, and Barack Obama nominated her, in 2013. But there’s also another possibility. Trump may believe that, with Yellen out of the way, it will be easier for him to lay claim to some of her achievements.
These achievements include overseeing a historic period of job creation. “Under Yellen, the U.S. unemployment rate has fallen the most of any Fed chair term in modern history,” the Washington Post’s Heather Long pointed out last month. In February, 2014, when Yellen took office, the unemployment rate was 6.7 per cent; today, it is 4.1 per cent. And almost three quarters of that decline came before Trump entered office.
It should also be noted that, when Yellen took office, most economists believed that an unemployment rate below five per cent, or thereabouts, would lead to inflation. If the unemployment rate fell below a certain key level, the textbooks said, prices would start rising. To head off an inflationary spiral, the Fed would have to step in and raise interest rates sharply—and such a move would risk a recession.
Yellen disputed this mechanistic view. Citing the fact that millions of people had ceased looking for jobs during and after the Great Recession of 2007-2009, she argued that the headline rate of unemployment was an inadequate measure of the state of the labor market, and that other metrics, such as the labor-force-participation rate, also needed to be taken into account.
More controversially, she also argued that there could be important benefits to the Fed running a “high-pressure economy,” in which the unemployment rate was kept low and new hires were hard to find. In such a situation, Yellen speculated, in a 2016 speech, workers who had dropped out of the labor force could be drawn back in, firms could be incentivized to make capital investments, over-all demand in the economy could be higher, and wages and productivity growth—which were languishing badly—could pick up.
This argument harkened back to one made during the nineteen-sixties by an earlier generation of Keynesian economists, including James Tobin, Yellen’s thesis supervisor, and Nicholas Kaldor, the British theorist and policy adviser. With the rise of monetarism, new classical macroeconomics, and so-called New Keynesianism, this type of economics fell out of fashion. But, as Yellen perceived, it could perhaps hold the key to breaking the recent pattern of low growth, low rates of capital investment, and stagnant wages.
The experience of the past eight years shows that it took a big dip in the unemployment rate for median household incomes to recover some of the losses they had suffered during the recession. Only when the jobless rate fell below the level previously considered safe did hourly wages rise by more than the inflation rate. Yellen welcomed these developments and sought to extend them rather than choke off growth prematurely. Even now, in the ninth year of the post-2009 economic recovery, the federal funds rate is only 1.5 per cent. The rate of inflation, as indicated by the Fed’s preferred measure, is also just 1.5 per cent—below the Fed’s official target of two per cent.
It could be argued—and it has been argued—that, with such a low inflation rate, the Fed has no business raising rates, even slowly. However, a case can also be made that the Fed’s expansionary policies are responsible for a stock-market boom that is now turning into a bubble. Sensitive to both of these critiques, Yellen’s Fed has been removing the monetary stimulus slowly, in baby steps.
Thanks to Trump and the Republicans, the Fed now faces another challenge, in the form of an additional boost to the economy provided by a front-loaded tax cut. Should the Fed stick to its current policy stance and accommodate this new stimulus? Or should it perhaps accelerate its interest-rate hikes? Yellen won’t have to make that call. The onus will be on Powell, who must be keenly aware that any hint of the Fed adopting a more hawkish approach will bring down upon him a Presidential Twitter fusillade and more—including the possibility of disruptions in the markets. Yellen certainly deserved another term, but she may be getting out at the right time.