Janet Yellen, the monetary dove

March 15, 2010

By Martin Hutchinson and Rob Cox

Janet Yellen has a reputation as a monetary dove. After all, she thought deflation a risk when she became president of the San Francisco Federal Reserve, and has suggested inflation may be too low now. But Ms. Yellen displays hints of talons beneath her feathers that could change the way the central bank does business.

Of the three new possible Fed governors to be proposed by the Obama administration, Ms. Yellen would be most influential in setting monetary policy. As a member of the Federal Open Market Committee she universally voted with the majority, but has hinted recently she thinks inflation is undesirably low – running below 2 percent.

For those concerned about incipient inflation stemming from the extraordinary influx of money into the economy, all this could be worrying. Reported consumer price inflation in 2004 was 3.3 percent, but a third of that comprised “owners equivalent rent,” an artificial construct imported into the CPI in 1980.

Now, replace the 2.5 percent rise in owners equivalent rent with 2004’s 16.2 percent rise in house prices nationwide, and the actual living cost inflation experienced by Americans comes to a theoretical 7.4 percent – suggesting that deflation was the last thing the Fed should have been worrying about. Of course, the Fed’s mandate has been to target consumer price stability, rather than asset price stability.

But in a November speech Ms. Yellen said that while using interest rates to fight asset price inflation was “costly”, the recent financial crisis had “prompted many of us to reexamine the widely held view that monetary policy should respond to asset prices only to the extent that they influence the anticipated trajectories of inflation and unemployment.”

She has said the Fed needs other policy tools for combating bubbles. Ms. Yellen has also said repeatedly that the high inflation of the 1970s was partly the result of monetary policy blunders that shouldn’t be repeated.

Fed Chairman Ben Bernanke’s views were formed by his work on the Great Depression, when the Fed failed to respond adequately to a collapse in money supply caused by widespread bank failures. He has prioritized avoiding the mistakes of the 1930s. If avoiding 1970s-style inflation and this decade’s asset bubbles and their associated hidden price rises is indeed a top priority for Ms. Yellen, her contribution to Fed policy may be less dovelike than the public record would suggest.

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