When the internet erupted with commentary about President Obama's official selection of Janet Yellen to be the next Fed Chair, I deliberately decided to write about the largely overlooked FOMC minutes released an hour before the President's press conference. Now that a few days have passed, I am going to distill down the important points about Dr. Yellen's appointment.
Although this is not usually touted as a key trait for a leader of a technocratic organization, I suspect Dr. Yellen's personality and notoriously diligent work ethic (in economic circles she if often referred to as a "rigorous thinker") will play a key role in her leadership style. Writing specifically about her humility, University of Michigan economics Professor Justin Wolfers said:
I remember being a visiting scholar at the San Francisco Fed when she was president of the bank. Typically, Fed presidents remain safely cloistered in the executive offices, away from the great unwashed. Not Janet. It wasn't unusual to see her in the cafeteria, tray in hand, looking for a table of friendly economists to join. She had an enviable ability to make even the most junior staffers feel at ease and valued.
I suspect this humility will not only allow Dr. Yellen to relate to the common man affected by Fed policy, but also to her staff and colleagues on the Board.
Aside from the personality traits that will undoubtedly impact her leadership style, the two most important leadership traits Dr. Yellen possesses are her skills as a consensus builder and her willingness to embrace conflict when necessary. Both of these skills contrast from Chairman Bernanke, although he has proven himself to be a reasonably good consensus builder.
Writing specifically about her consensus building skills, Bloomberg News stated:
In spite of her identification as a leading dove, Yellen has shown an ability to forge consensus with the more hawkish, anti-inflation members of the Federal Open Market Committee -- a quality that could come in handy as the central bank wrestles with when and how to unwind all the stimulus it has pumped into the economy.
This statement was followed by the observation that Yellen has gone out of her way to meet with Fed district bank presidents on a number of occasions.
Yellen's calendars, obtained under the Freedom of Information Act, show more than 90 meetings by phone or in person with Fed district bank presidents in 2011 and 2012, when she visited the Boston, New York, Philadelphia, Atlanta, Cleveland, Chicago, Minneapolis and San Francisco.
While Dr. Yellen's consensus building skills have been reasonably well reported for several months, the more interesting point about her leadership style is undoubtedly her assertiveness, as reported by The New York Times:
Ms. Yellen is also a more assertive leader than Mr. Bernanke and appears less averse to conflict. While both encourage open debate and seek to make decisions by consensus, Ms. Yellen has been a more vocal and persistent advocate for her own views. Mr. Bernanke has allowed Fed officials to air their views freely, while Ms. Yellen has expressed concern that the cacophony undermines the Fed's effectiveness by sowing confusion about the direction of policy.
The New York Times article went on to explain Dr. Yellen's willingness to challenge the Maestro himself, Alan Greenspan:
Ms. Yellen was the rare Fed official to challenge Mr. Greenspan and succeed. In 1996, she marshaled academic research, including a paper she had encouraged Mr. Akerlof to write, to argue that the Fed should seek to moderate inflation rather than eliminate it. The research showed that a little inflation helped to minimize unemployment. Employers that were reluctant to impose wage cuts could instead allow inflation to erode the real value of wages, allowing them to reduce labor costs.
The Times article continued by pointing to Yellen's role in building internal support for the explicit 2% inflation target (a move with which I disagree). Perhaps more important, the article also quoted Peter Orzag referencing Dr. Yellen's "rigorous" thought process in a veiled reference to Brad Delong's point that Dr. Yellen would be an excellent Fed Chair in normal circumstances, but perhaps not as good in a crisis where creative policy decisions must be made quickly. Orzag said:
I could see why people believe she's particularly good at situations in which there are important decisions to be made that involve pulling facts and weighing consequences carefully without pulling the trigger right away.
Stepping away from the personality and leadership traits of Dr. Yellen into the more important policy issues. One thing is very clear about how a Yellen Chairmanship will unfold: communication is key. As Tim Duy systematically evaluated, the Fed's existing communication policy is confusing and lacking strategic vision; it needs improvement. Given that Dr. Yellen has been the head of the communication subcommittee at the Federal Reserve Board for the last couple years, she certainly knows more about the existing strategy than anyone else and has played a bigger role in expanding communication over the last couple years than basically any other individual in Fed history. However, that does not mean she is the best person to improve the Fed's communication strategy.
In recent months she has been in almost open dispute with Fed Board member Jeremy Stein who has suggested that communication can have a magnified effect and thus induce market volatility in the form of wider rate spreads. This led Stein to advocate for tapering the Fed's asset purchases sooner as opposed to later. Although the Yellen camp obviously won this argument at the September FOMC meeting (with Stein also voting to sustain the current pace of asset purchases), the market (over)reaction to talk of tapering and the ensuing dispute between Yellen and Stein highlights the need to more tightly manage Fed communication.
Perhaps Dr. Yellen's more "assertive" leadership style (than Chairman Bernanke) will serve her well in managing communication, but it is also important to note that modern Fed communication is more complex than ever before. For instance, in highlighting the difficulty in managing forward guidance, Felix Salmon writes:
…it's one thing for a Fed chairman to rally his FOMC troops and get them all to agree on a certain course of action at a certain meeting. It's another thing entirely to try to get those troops to agree to a future course of action, stretching out as far as mid-2015, despite the fact that no one really knows what the economy is going to look like then.
Salmon suggests that Yellen manage the cacophony not by squelching out dissenting voices, but by embracing them. He suggests that Dr. Yellen make it clearer than ever before that FOMC members disagree, but that policy is going in a particular direction based on committee consensus. While I like this strategy in theory, I think it would be very hard to manage in practice and runs the risk of diminishing Fed credibility the way the Supreme Court has diminished their own with so many 5-4 decisions. It is far more likely that as Chairman, Janet Yellen will limit communicators to stay on point in an effort to provide a clear signal about monetary policy.
Global Market Response
Thus far the global market response to the Yellen nomination has been pretty subdued. Developing markets responded favorably to the prospect of continued stimulus, but with a little trepidation about the possibility of a weaker dollar. Perhaps more important is the unrelated economic event of two of America's biggest trade partners, Europe and China, signing a currency swap deal. This marks a major step toward the Chinese Yuan becoming a global reserve currency. Although the timing is largely coincident with the Yellen nomination, this move is likely associated with perceived global weakness in the stability of the dollar due to the impending debt ceiling breach. It will be Chairman Yellen's job to ensure that the dollar remains a global reserve currency, despite the fiscal and monetary ramifications of strife between the Legislative and Executive branches.
Aside from the long term prospect of managing the dollar abroad, Dr. Yellen has already had an enormous impact on global central banking. In India, new central banker Raghuram Rajan has already followed Dr. Yellen's steps with an implicit inflation target. Similarly, Bank of England Governor Mark Carney has pursued an aggressive communication policy, similar to the one Dr. Yellen has advocated since rejoining the Fed in 2010. Perhaps the only dismissal of Dr. Yellen's policy proclivities comes from Chairman Bernanke's graduate school adviser and former head of the Bank of Israel, Stanley Fischer. Dr. Fischer has suggested that forward guidance and the plethora of other new communication policies confuse markets and run the risk of diminishing central bank credibility. While I do not expect this view to sway Dr. Yellen, it is worth revisiting to see if she at least manages the forward guidance strategy more precisely.
Hawk or Dove?
While the media narrative has consistently categorized Dr. Yellen as a dove, I think this is not completely fair. In the 1990s she expressed hawkish inflation views about the dangers of asset bubbles, and although slow to repeat these concerns in the 2000s, she was still ahead of the curve in spotting the crisis on the horizon. Perhaps more important than her individual past is the history of other Fed Chairmen. Specifically, new Fed Chairs have historically been quick to raise interest rates and tighten policy in order to establish their credibility as an inflation fighting central banker. To be fair, economic cycles have lent themselves to this pattern, but the pressure to establish credibility is definitely there. Nevertheless, I suspect the pressure on Dr. Yellen will be more towards generating continued job growth since inflation remains low and stable and her challenge appears to be persistently high unemployment.
Will all of the commentary, anecdotes and other information available about Janet Yellen, I think it is exceedingly unlikely that markets will be surprised by her leadership style or policy outcomes. So, investors and traders should expect an extension of the Bernanke years in terms of loose policy designed to stimulate job growth, but investors might also be pleasantly surprised (and traders slightly dismayed) by a tighter and more carefully managed communication strategy that avoids undue market confusion and increased volatility.