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An ode to Janet Yellen

Myles Udland
Markets Reporter

On October 9, 2013, President Barack Obama announced that he would nominate Federal Reserve vice chair Janet Yellen to be the next head of the central bank.

“I’m absolutely confident that she will be an exceptional chair of the Federal Reserve,” Obama said.

This prediction turned out to be correct.

Federal Reserve Chair Janet Yellen will be remembered fondly by markets and economists for seeing the economy through the end of an unprecedented time in the Federal Reserve’s history. Yellen’s four-year term as Fed chair ends on Feb. 3, 2018. (AP Photo/Jacquelyn Martin)

On Wednesday, the Federal Reserve raised interest rates for the third time in 2017 and the fifth time since the crisis. Each of these rate hikes occurred during Yellen’s time as chair. Additionally, the unemployment rate is at 17-year low, stocks are at a record high, and most economists see the U.S. entering the 2020s without another recession.

And with Yellen’s time at the top of the Federal Reserve set to end in February, it is clear that her tenure at the central bank has been a resounding success. The economy is doing as well as it has since the financial crisis and the market’s faith in the Yellen Fed has only grown through time.

But when Yellen — a veteran of the Federal Reserve system who served as president of the San Francisco Fed and as vice chair before taking the top job from Ben Bernanke — took over as Fed chair, the economic scars of the financial crisis were a fresh memory for markets and the public.

In late 2013, The Atlantic wrote that Yellen would be “inheriting a job that has never been as important as it is right now.” So for the first female chair in the history of the Federal Reserve, there was little doubt about how high the stakes would be.

And the path to success for the Yellen Fed was filled with obstacles, both known and unknown.

Upon assuming office Yellen’s task was clear — return Fed policies to something resembling the pre-crisis era. In February 2014, the Fed was still in the middle of its third round of asset purchases and interest rates were pegged near 0%. The unemployment rate was 6.7%

Less than a year before Yellen was sworn in, Bernanke had rattled markets with the mere hint of winding down the Fed’s $85 billion worth of monthly assets purchases. Bond markets took six months to recover from what was later called the “Taper Tantrum.”

Then, six months into Yellen’s tenure, oil prices cratered, which weighed on inflation, hurt corporate profits, and led to questions about the strength of the U.S. and global economic recovery. The road to policy normalization would be a winding one.

A ‘legend’ and a risk

In the spring of 2013 — with Yellen emerging as a clear favorite to be the next Fed chair — The Wall Street Journal captured something of a mixed mood among the economics establishment at the suggestion that Yellen would be tasked with leading out its Fed from its crisis-era stance.

Willem Buiter, the chief economist at Citi, likened Yellen’s notes from her time as a student at Yale to scripture. Former Yale president Richard Levin called Yellen a “legend.”

Others, however, doubted that Yellen’s market-skeptical stance would be received by an investor class growing antsy with the Fed’s post-crisis response.

“I think market participants are nervous about [Yellen],” Vincent Reinhart, then chief U.S. economist at Morgan Stanley, told the Journal. Reinhart pointed to a speech given in February 2013 at an AFL-CIO conference, in which she discussed the “painfully slow” economic recovery for many American workers. The market-wary interpretation here being that by seeing easy monetary policy — that is, keeping rates low and continuing asset purchases — as the fix for an ailing labor market, a Yellen-led Fed would risk triggering a rapid uptick in inflation.

And by any reasonable measure, Yellen rose to the occasion during her tenure and will leave her post with the U.S. economy in better shape than even she and her peers had expected.

U.S. President Barack Obama applauds after announcing his nomination of Janet Yellen to head the Federal Reserve at the White House in Washington. October 9, 2013. (REUTERS/Jonathan Ernst/Files)

In December 2013, the Fed’s own Summary of Economic Projections (SEP), which shows expectations for future economic progress from Fed officials, indicated that in the long run, the unemployment rate would settle between 5.2%-5.8%. In November 2017, the unemployment rate was 4.1%.

These same projections, however, also overstated GDP growth, inflation, and interest rate hikes over the long term.

Yellen’s seemingly worrisome focus on the unemployment rate, then, proved to be warranted given the evolution of the U.S. economy in the last four years. The economy could simply tolerate a far lower unemployment rate than many of Yellen’s peers believed.

And the markets, with their laser-tight focus on inflation and interest rates, came to embrace the chair’s approach.

The Fed beyond Yellen

In recent months, Yellen has made waves by characterizing the low inflation we’ve seen in 2017 as a “mystery.” Because while the unemployment rate tolerated by the economy is lower than many had expected — as Yellen suggested before being named Fed chair — at 4% unemployment most all economists would’ve expected to see some uptick in prices.

Wednesday’s latest SEP from the Fed indicates that officials see the central bank raising interest rates three times in 2018. And as we noted Tuesday, economists at Goldman Sachs expect the effective Fed Funds rate to be north of 3% by the end of the decade.

These same projections from the Fed, however, don’t see inflation reaching its 2% target until 2019 and at least some staff members expect long-run inflation to remain below this level. So for incoming chair Jerome Powell, how quickly and how high to raise interest rates in the face of below-target inflation and modest wage growth will be the key question as the Fed’s balance sheet wind-down appears to be on autopilot.

But as Yellen discovered early in her term, the economy will always present central bankers with a challenge — a stock bubble for Alan Greenspan, a financial crisis for Ben Bernanke, and persistently low inflation for Janet Yellen.

How Powell navigates this certain hiccup will define his legacy and the path of the economy under his stewardship.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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