The Ultimate "What Would Janet Yellen Do?" Cheatsheet

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Pulling from an extensive record of public speeches and FOMC meeting transcripts, Goldman Sachs reviews Fed Chair-nominee Janet Yellen's views on a number of policy-relevant issues. Probably the most differentiating feature of Yellen's public communications relative to other Fed officials has been her focus on "optimal control" considerations in illustrating potential future paths for the fed funds rate, which generally suggest a more accommodative path than current consensus expectations.

Yellen has expressed confidence in the benefits of QE in the past, and has generally not suggested that the costs of QE are substantial enough to warrant any changes to the stance of policy.

She believes that most of the increase in unemployment since the crisis has been cyclical rather than structural in nature, and will be looking for a broad-based improvement in labor market indicators before deciding that a "substantial" improvement has occurred.

FOMC meeting transcripts show that Yellen generally erred on the side of preferring more accommodation during 2006 and 2007 (detailed transcripts are delayed 5 years), but expressed significant concern about inflation during the mid-1990s.

Via Goldman Sachs,

What Does Janet Yellen Think?

On Wednesday, President Obama nominated Fed Vice Chair Janet Yellen to replace current Chairman Ben Bernanke when his term expires in January. Broadly, we expect the approach to monetary policy to be very similar under a Yellen Fed to that seen under the Bernanke Fed, and we believe the transition in the Chairmanship will be smooth, assuming Yellen is confirmed as we expect. We are not adjusting our baseline forecasts for monetary policy in any way in light of the Yellen news, which was overwhelmingly anticipated.

Although Yellen has generally erred on the side of not making public remarks in recent quarters, with her last speech occurring in June, there is an extensive historical record of her views while Fed Vice Chair (since October 2010), President of the San Francisco Fed (June 2004 - October 2010) and Fed Governor (August 1994 - February 1997) available to the public. In today's Daily, we provide a brief recap of views Yellen has expressed on topics of current policy interest in past speeches, as well as a short summary of her views on past Fed policy decisions as revealed by detailed FOMC meeting transcripts available through 2007.

Optimal control

Probably the most differentiating feature of Yellen's public communications relative to other Fed officials has been her focus on "optimal control" considerations in illustrating potential future paths for the fed funds rate. She referred to these simulations in three separate speeches, in April, June, and November of 2012. Under such an approach, the FOMC chooses a path for the federal funds rate which best meets its objectives over the next several years as a whole, even if this means committing to a policy that may appear suboptimal at certain points along the way. The latter point is particularly important for the optimal control approach. For example, Yellen stated in the November 2012 speech that if 2% inflation is the Committee's goal, then 2% cannot be viewed as a ceiling. Under optimal control, inflation is allowed to overshoot the Fed's 2% objective as long as it is helpful for bringing unemployment down more quickly.

Our latest replication of Yellen's optimal control rule suggests rate hikes may start in early 2016, somewhat later than the consensus expectation of around 2015Q3. However, Yellen has relatively strongly caveated the optimal control approach in the past, noting that she commonly considers a number of different approaches. For instance, she has in the past referred to more traditional policy rules such as the "balanced approach" Taylor rule?a version of the Taylor rule with a higher weight placed on unemployment. She also noted that she considers it "imprudent" to rely entirely on optimal control exercises, given their sensitivity to modeling assumptions.

The real neutral fed funds rate

The real neutral fed funds rate is defined as the rate that would be consistent with full employment and stable inflation over the medium term. A number of fed officials, including Bernanke and Dudley, have suggested that the real neutral fed funds rate might be lower than its historical average given persistent headwinds to the economic recovery. In other words, the federal funds rate at 0 to 25 basis points might be providing less stimulus to the economy than it would have historically. Yellen agrees with this view, noting in June 2012 that the real neutral rate is probably "well below its historical average." Furthermore, as detailed in the December 2007 FOMC meeting transcript, Yellen partly justified her preference for a 50 basis point rate cut (vs. the 25 basis point cut ultimately adopted) by appealing to the likelihood of a lower real neutral rate.

Forward guidance

Yellen strongly endorsed outcome-based (rather than calendar-based) forward guidance on the path of the fed funds rate, in March of this year and again in April, calling it a "major improvement." Specifically, she views outcome-based guidance as reducing uncertainty about whether changes to calendar-based forward guidance might reflect changes to the Fed's reaction function or the Fed's forecast for the economy. (She has not spoken on this issue more recently, since disadvantages of the unemployment rate-based thresholds have become more apparent in light of the continued drop in labor force participation and greater volatility in market-implied expectations for the date of the first rate hike.)

With respect to the potential for enhancing the forward guidance in the near-term, Yellen noted in March that "the Committee could decide to defer action even after the unemployment rate has declined below 6-1/2 percent if inflation is running and expected to continue at a rate significantly below the Committee's 2 percent objective. Alternatively, the Committee might judge that the unemployment rate significantly understates the actual degree of labor market slack." This remark was very similar to Chairman Bernanke's remark at the last FOMC press conference: "The committee would be unlikely to increase rates if inflation were projected to remain below our 2 percent objective for some time, for example. And in making its assessment, the committee would also take into account additional measures of labor market conditions such as job gains. Thus, the first increases in short-term rates might not occur until the unemployment rate is considerably below 6.5 percent."

We believe that Yellen will be supportive of enhancing the forward guidance in the future, in particular taking into account previously-mentioned considerations on optimal control and the real neutral rate. Furthermore, the uncertain transition in Fed leadership was noted in the September meeting minutes as a factor potentially influencing the Committee's decision not to change forward guidance at that time. If Yellen is confirmed as we expect, this will of course be a non-issue.

The efficacy of QE

Yellen has spoken favorably about the efficacy of quantitative easing in the past, noting for instance in March that a hypothetical $500 billion asset purchase program might be expected to lower the unemployment rate by close to 0.25 percentage point after three years. However, she has not updated her views publically since the tide began to turn decidedly in favor of forward guidance as the "preferred" policy tool, as we have written about recently. At the last post-FOMC press conference, Chairman Bernanke noted that "it's our view that … rate policy is actually the stronger more reliable tool" relative to asset purchases.

On several occasions, Yellen noted the importance of market participant's expectations for the Fed's intended holding period for longer-duration securities in determining the ultimate impact on financial markets and by extension the economy. As a result, it is possible that we could receive more explicit communication on this under a Yellen Fed. Over the past year, Fed officials have been gradually guiding the market away from expecting outright asset sales to be a significant part of the exit strategy.

On the topic of the efficacy of MBS vs. Treasury purchases in stimulating the economy, Yellen has not made as explicit a statement in favor of MBS purchases as some Fed officials have (such as Williams, Stein, and Rosengren). However, she has stated that "research suggests that our purchases of mortgage-backed securities pushed down MBS yields and that MBS yields pass through, with a lag, to mortgage rates," without making any parallel positive statement about Treasury purchases at that time. In addition, in 2009 while noting that she believes the Fed should eventually return to a Treasury-only balance sheet once the economy is back to normal, she stated "I also am convinced that, in the current crisis, we must employ all available tools, and that includes bolstering private credit markets."

Costs of QE

Yellen has generally not viewed potential costs of QE as similar in magnitude to the benefits. While noting the possibility that costs of QE could become more important in the future, Yellen noted in March that there was "no evidence" that the Fed's purchases were negatively impacting market functioning and stated in April that there was "no pervasive evidence" of any financial imbalances caused by the Fed's asset purchases. Since then, MBS market functioning has likely worsened somewhat, however we expect that she would probably maintain an unchanged view on financial imbalances. She similarly downplayed other potential costs of QE, such as the possibility of cancelled remittances to the Treasury Department.

The labor market

The labor market has been a long-standing point of focus for Yellen, who?like many Fed officials?typically describes the Fed missing its mandate in terms of too-low labor utilization rather than too-low inflation. She has on several occasions reiterated her view that "the bulk" of the elevated unemployment rate is due to cyclical rather than structural factors. In February of this year she highlighted several academic papers in support of her view, including work from Lazear & Spletzer, and Rothstein. Furthermore, she has referred to broader measures of labor market underutilization on several occasions, including the "U6" measure of unemployment in March, and the "millions … who left the labor force" in June 2012. Avoiding "hysteresis"?cyclical slack gradually metastasizing into a structurally lower participation rate?has been a key consideration for Yellen in maintaining the highly accommodative stance of monetary policy.

Regarding which indicators Yellen would be watching to discern whether a "substantial" improvement in the outlook for the labor market has occurred?the condition to which the Fed has tied ending QE?she listed five indicators in March: (1) the unemployment rate, (2) payroll job growth, (3) the hiring rate, (4) the quit rate, and (5) the overall rate of economic growth. In our view, only the first of these looks significantly better since the spring of this year, although we expect a pickup in the labor market and broader economic activity into 2014.

Why the recovery has been so slow

In February Yellen laid out her view of why the recovery has been so disappointingly slow to date, despite the accommodative stance of monetary policy. She appealed to five factors holding back growth: (1) US fiscal policy, which while expansionary early in the recovery has become contractionary, (2) idiosyncratic underperformance of the construction sector?normally an important part of the transmission mechanism for monetary policy?in light of the slow recovery from the housing bust, (3) depressed household expectations for income growth, in contrast to past recessions, (4) the European fiscal crisis weighing on US exports, and (5) other potential blockages in the transmission channels for monetary policy in light of post-crisis credit constraints. Indeed in July 2009, Yellen forecast that the recovery would be "painfully slow," citing Reinhart and Rogoff's work on historical recoveries from financial crises.

Past monetary policy decisions

The FOMC releases detailed meeting transcripts?unlike the meeting minutes which do not ascribe views to specific individuals?with a five-year lag. At present, transcripts are available through 2007. Based on our review of the transcripts, we find that Yellen more often than not erred on the side of preferring more monetary accommodation than the Committee consensus, in particular in recent years.

 

For example, as detailed in Exhibit 2, Yellen favored a more aggressive rate cut at the December 2007 meeting at the start of the recession, and was reluctant to continue hiking rates at the tail end of the 2004 - 2006 tightening cycle. However, this was not always the case. Yellen agreed with the consensus that it was time to begin tightening policy in June 2004, and was notably concerned about inflation during 1996, a point recently highlighted by a number of media sources. At that time there was more of a case to be made that the economy was close to or exceeding full employment, although in the event, inflation remained friendly.