She is not hawkish on inflation

An interpretation of Fed Chair Janet Yellen; Dialogue with the Alter Ego

“While conditions in the labor market have improved appreciably, they are still far from satisfactory. Even with recent declines in the unemployment rate, it continues to be elevated. Moreover, both the share of the labor force that has been unemployed for more than six months and the number of individuals who work part time but would prefer a full-time job are at historically high levels. In addition, most measures of labor compensation have been rising slowly–another signal that a substantial amount of slack remains in the labor market. (…) the Federal Open Market Committee (FOMC) recognizes that inflation persistently below 2 percent–the rate that the Committee judges to be most consistent with its dual mandate–could pose risks to economic performance, and we are monitoring inflation developments closely.” –  Chair Janet L. Yellen, The Economic Outlook, Before the Joint Economic Committee, U.S. Congress, Washington, D.C. , May 7, 2014 –

Question by Alter Ego of Noah denkt™ (AE): On May 7, we watched for the first time a live testimony of the new Federal Reserve Chairwoman Janet Yellen to the Joint Economic Committee of the US Congress. Now, we are well aware that historically criticism of Fed Chairs is cheap. Hardly any Fed Chair, perhaps with the exception of Mr. Volcker, has survived his tenure without being blamed for at least one major mishandling of monetary policy. Having said this, it is still quite important to debate the economic views of a sitting Chair publicly, if only to go on record and thereby be accountable for one’s own take. So, with that in mind we would like to ask Noah denkt™ what this project takes away from Ms. Yellen’s testimony?

Answer by Noah denkt™ (Nd): Thank you for setting the stage so well with your opening question. Clearly, it isn’t easy to be a Fed Chair. And none of us knows whether he or she could live up to the challenges that the top job at the Federal Reserve entails. But we agree that public debate is necessary and that we should, therefore, speak our mind open and freely.  And in that respect, we cannot answer your question without admitting that Ms. Yellen’s May 7 testimony reinforced an impression that we had earlier of her which is that she will not be an inflationary hawk and that she will continue to be overly concerned with fulfilling the social policy part of the dual mandate that the Fed has.

AE: Which is?

Nd: To steer the economy towards full employment.

AE: But what’s wrong with that?

Nd: Well, in our mind, it is quite doubtful whether the economy will ever again reach the kind of full employment that we were used to before the digital revolution reached the point it is at now. (i.e. low long-term unemployment, more full-time employment contracts as opposed to many part-time employments, a fair salary structure etc…) In other words, we believe it is mistaken to apply pre-crisis labor market expectations to the post-crisis reality. And there are several reasons why this is wrong:  First, it seems quite reasonable to presume that societies will continue to be ever more unequal given that it is in the very nature of a media driven mass economy to gang-up on celebrities and leave the no-names behind. Then there is the technological advance which will certainly create more high paying jobs at the upper end of society but which will equally demand an ever larger sector of low paying service jobs at the bottom. In between however the job space will continue to erode in the same measure that the middle class is disappearing. And finally, we mustn’t forget that people tend to be ever more self-obsessed and therefore less likely and capable to integrate themselves into a regular work discipline. And companies will consequently be even less inclined to burden themselves with a host of long-term employment contracts than they are now.

AE: So, in your mind, Ms. Yellen pursues an antiquated goal which due to its inappropriate antiquity will cause serious imbalances in the economy?

Nd: This is what we believe.

AE: And how exactly will this play out.

Nd: Well, it seems quite likely to us that she will keep interest rates down for too long and thereby create an inflationary spike that will be hard to deal with. After all, she doesn’t appear to be a great inflation hawk. Instead, she seems to hold the view – which by the way was already spreading under Mr. Bernanke – that inflation must be dealt with when it presents itself and not ahead of time.

AE: Could you expand on that?

Nd: Look, there used to be a time when the consensus was that national economies and monetary policy are like supertankers which need to initiate their manoeuvers well ahead of time in order to get where they want to be later on. That view seems to have given way, however, to an interpretation that believes that such changes can be made more on the spot and with less cautious anticipation. And that is why Ms. Yellen is more concerned with the effects of low inflation (under 2%) than with the effects of a spike that might take the economy beyond 2% (see her comment above).

AE: But how can you say that? After all, she made it a very clear in her response to Rep. Hanna that the Fed has learned the lessons from the Volcker years and will hence show quite some resolve when dealing with inflationary pressures. (“I do believe that we have the tools and absolutely the will and the determination to remove monetary accommodation and at an appropriate time to avoid an overshooting of our inflation objective.” See, Min 57 onwards)

Nd: This is easier said than done. The evidence for pin-pointing the right moment to go hawkish is usually murky. And there are always huge political and public relation pressures that work against the implementation of a tougher monetary policy. You have to think about this is in the same way that you think about government subsidies. They are easy to introduce but very hard to remove because over time too many people get “oh so” used to the presence of these subsidies. Hence, they will find a lot of good arguments to defend the status quo.

AE: Is it fair then to say that Ms. Yellen’s approach has you somewhat worried?

Nd: That is correct because ultimately it is up to governments and not monetary institutions to conduct social policy.

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