For Yellen, a focus on reducing unemployment

For Yellen, a focus on reducing unemployment
Berkeley, Calif.: When the economists Janet L. Yellen and George A. Akerlof hired a baby sitter for their son in the early 1980s, they decided to pay more than the going wage. They reasoned that a happier baby sitter would provide better care.

The decision not only attracted a series of excellent sitters, it also inspired the couple, both professors at the University of California at Berkeley, to develop a new theory of the labor market that remains an influential justification for the Federal Reserve's ability to stimulate job growth.

Employers, they asserted, often seek to improve morale by paying more than the minimum necessary wage, which has the effect of preventing some people from finding jobs. And during periods of high unemployment, they said, monetary stimulus can increase demand for labor - a direct rebuttal to the classical view, which left little role for the Fed in combating unemployment.

Thirty years later, Yellen and the debate about the Fed's abilities have both moved from the theoretical world of academia to the Fed itself. As the central bank's vice chairwoman since 2010, she has pressed for stronger measures to reduce unemployment, battling the doubts of other Fed officials about the value of continuing to expand the Fed's enormous stimulus campaign.

Yellen, 67, now finds herself as President Barack Obama's nominee to succeed the Fed chairman, Ben S. Bernanke, at the end of January, largely because many Democrats view Yellen as the best person to press that stimulus campaign and to strengthen financial regulation. Senate Democrats prevented the nomination of Obama's first choice, Lawrence H. Summers.

For Yellen, who was drawn to study economics as a path into public service and aspired as a college student to work at the Fed, the top job at the central bank would be a logical if - until only recently - unexpected culmination. Her confirmation also would reinforce the Fed's evolution from an institution run by market-wise bureaucrats focused on controlling inflation to an institution run by academics committed to a broader mission of steady growth and minimal unemployment.

Yellen's intellectual roots and leadership style both suggest that she would push somewhat more forcefully than Bernanke to extend the Fed's stimulus campaign, according to a review of her career and interviews with more than two dozen colleagues and acquaintances.

She has expressed greater concern about the economic consequences of unemployment, a stronger conviction in the Fed's ability to stimulate job growth and a greater willingness to tolerate a little more inflation in order to reduce unemployment more quickly. Until recently, her emphasis on unemployment would likely have disqualified her for the job, and it has already inspired opposition from some Senate Republicans and investors concerned that she would not be sufficiently vigilant in guarding against inflation.

Yellen is also a more assertive leader than Bernanke and appears less averse to conflict. While both encourage open debate and seek to make decisions by consensus, Yellen has been a more vocal and persistent advocate for her own views. Bernanke has allowed Fed officials to air their views freely, while Yellen has expressed concern that the cacophony undermines the Fed's effectiveness by sowing confusion about the direction of policy.

"I think she is fundamentally committed to continuity, that we still have a problem and we still need monetary policy to be doing a fair amount," said Christina D. Romer, a former chairwoman of Obama's Council of Economic Advisers and a close friend of Yellen's. "There's a toughness there, and I think there's a toughness to her that there isn't in Bernanke."

Yet it is easy to overstate the changes Yellen likely would bring. She would be the first Democrat to lead the Fed in nearly three decades, but a liberal central banker is something different from - and more conservative than - a liberal politician. She was instrumental in the Fed's decision last year to declare a target of 2 percent annual inflation, and has shown a very limited willingness to tolerate higher inflation.

On regulatory issues, too, Yellen's views are closer to those of the Obama administration than to those of the left-leaning Democrats most fervently seeking her nomination. She believes markets are imperfect and require significant regulation. But she favored the emergence in the 1990s of financial giants like Citigroup and has not supported calls for their breakup.

And Yellen may find her own instincts constrained by the increasingly restive minority of Fed officials who want to start pulling back from the stimulus campaign.

Richard W. Fisher, president of the Federal Reserve Bank of Dallas - who will become a voting member of the Fed's policy-making committee next year as part of a regular rotation - is among those officials. Of Yellen, he said last week, "She's wrong on policy, but she's a darn good, decent, wonderful person."

Yellen, like many economists of her generation, was drawn to the field by an interest in the Great Depression. Economics allowed her to combine a love for the rigor of mathematics with a desire to work on issues affecting people's lives.

Born in New York City in 1946, she was raised in a middle-class neighborhood. Her mother, a teacher with an interest in finance, stayed home to raise Janet and her brother, John. Her father, a family doctor, saw patients in a home office he closed Wednesday afternoons so the family could spend time together.

Some of Yellen's classmates at Fort Hamilton High School, from which she graduated in 1963, remember a smart and devoted student who seemed a little removed from their teenage world of music, parties and political ferment.

"She was a good friend and a good companion," said Charles Saydah, who was in many of Yellen's classes and hung out with the same group of friends, which he described as "the kids who were interested in folk songs." But "from where I was sitting," Saydah added, "it was clear that this was a way station to better things" for her.

Each year, the editor of the student newspaper interviewed the class valedictorian. Yellen was both, so she interviewed herself. She talked about her love of travel, her rock collection - "I've been collecting rocks since I was 8 and have over 200 different specimens" - and her plans for college.

"I've decided to major in math or anthropology or economics or ..." she wrote. After enrolling at Brown University, it did not take long to narrow the list.

"She took her first economics course and came home and gave me the one-hour lecture on why economics was the greatest thing going," Susan Grosart, a childhood friend, said, recalling the Christmas vacation of their freshman year. "It was pretty obvious from then on that that was her passion."

Yellen decided to pursue a doctorate at Yale University after hearing a speech by James Tobin, the economist whom she still regards as her intellectual hero. Tobin was a staunch defender of the view that government policy could lift an economy from recession. She also admired the way he mixed academic work with public service.

"He encouraged his students to do work that was about something," Yellen told the Yale Daily News after Tobin's death in 2002. "Work that would not only meet a high intellectual standard, but would improve the well-being of mankind."

Yellen and Akerlof spent much of the 1980s trying to understand unemployment - at the office, at the dinner table and on vacation in Hawaii, where they rarely entered the water, preferring to read economics books on the beach.

The couple met in 1977 in a cafeteria at the Fed, where both had taken research positions. Yellen had not secured tenure after six years as a junior professor at Harvard University; Akerlof had been denied a full professorship at Berkeley.

"We liked each other immediately and decided to get married," Akerlof wrote in a personal history after winning the Nobel Prize in 2001. "Not only did our personalities mesh perfectly, but we have also always been in all but perfect agreement about macroeconomics. Our lone disagreement is that she is a bit more supportive of free trade than I."

They were both Keynesians, believers in the view that people act irrationally, markets function imperfectly and the resulting problems are not self-correcting; that the government must help.

"While admirers of capitalism, we also to a certain extent believe it has limitations that require government intervention in markets to make them work," Yellen said in a 2012 interview with Berkeley's business school magazine.

Friends describe Akerlof as a fountain of ideas, some brilliant, many indifferent. Yellen, they said, helped to frame a research agenda. She was a more rigorous thinker, and skilled at building and manipulating the theoretical models that are the primary tools of economic research.

"He would float an idea and she would say, 'Here are the nine reasons that's stupid,'" said the Berkeley economist David H. Romer, a longtime friend. "And if she could only think of four reasons," Romer said, then that was an idea worth discussing. He added, "It was an incredibly fruitful partnership."

In the summer of 1981, after returning to Berkeley, Akerlof and Yellen were looking simultaneously for child care and for an explanation of an old riddle: The persistence of unemployment. As it happened, they would find both in the same place.

"Faculty couple seeks child care person," read the classified ad in the July 24, 1981, edition of The Daily Californian, Berkeley's student newspaper. "Good pay."

It may seem obvious that many people without jobs would rather be working, but it is not so easy to explain why they cannot find work simply by reducing the price of their labor until companies find it profitable to hire them. In other words, during periods of high unemployment, why don't companies cut wages rather than laying off workers?

The answer put forward by Yellen and Akerlof sprung from their observation that people often overpaid baby sitters. They argued in a series of papers that many employers chose to pay workers more than the cost of replacements because higher morale resulted in higher productivity. During recessions, when the market price of labor is falling, employers similarly refrain from cutting wages, because lower morale would diminish productivity. Employers do not save money if output falls, too.

"Firms don't just try to pay as little as possible to get the needed bodies on board; when there is unemployment, they ask themselves how wage cuts would affect the behavior of the employees," Yellen said in a 1995 interview. "Would they quit or feel dissatisfied and work less hard on the firm's behalf if they feel that wage policies are unfair?"

This reluctance to adjust wages, in turn, helps to explain why monetary policy works. When the Fed tries to stimulate the economy by increasing the availability of money, it is clear that spending increases. But economists have long debated whether the result is that people buy more goods and services or simply pay higher prices for the same things. In other words, does monetary stimulus just cause inflation, or can it also produce economic growth?

The argument hinged on whether prices adjusted quickly. Defenders of monetary stimulus argued that the price of labor, in particular, was "sticky" - that wages often did not adjust quickly. People were spending 10 percent more money, companies were earning 10 percent more, but wages remained the same. As a result, companies could afford more workers.

Yellen and Akerlof saw their theory as an explanation for the stickiness of wages. Perceptions of fairness, they said, might not be immediately affected by changes in the money supply. At least some employers would not adjust wages. And as a result, stimulus could increase growth.

Other economists advanced competing explanations for "sticky wages." The economist whose account most closely resembled Yellen's and Akerlof's, in their view, was none other than Summers, Yellen's rival to succeed Bernanke.

Yellen also collaborated with Akerlof, and sometimes other colleagues, on a string of other projects that used economic analysis to grapple with policy issues. They analyzed the profitability of East German companies and proposed policies to ease unemployment during unification; they evaluated crime prevention strategies and found evidence for the importance of encouraging community members to report crimes; they evaluated the causes of out-of-wedlock births and warned that proposed changes in welfare benefits were unlikely to make a difference.

Yellen also was a devoted teacher. She wrote lecture notes in longhand and Andrew K. Rose, a Berkeley colleague, recalled that she would begin by writing, "Hello. My name is Janet Yellen."

Students recall her patience and willingness to explain concepts repeatedly. Those who took her macroeconomics class in the years after she returned from her first tour of duty in Washington also remember her stories about life there.

"She would talk about the cafeteria at the Federal Reserve," said Kathy Poettcker, who took Yellen's class in 2003. "She'd tell you, 'You'd think it's some elaborate sort of setup, that there should be place mats and servers and white linen. Instead it was cottage cheese and canned fruit on a plastic plate.' She'd laugh and you're realize she's just a normal person doing normal things."

Yellen's first term on the Fed's board of governors, for three years beginning in 1994, foreshadowed the positions she has taken in recent years.

President Bill Clinton nominated her alongside another liberal academic, the Princeton University economist Alan S. Blinder, to temper the market-oriented conservatism of the Fed's chairman, Alan Greenspan. Appointing academics was an unusual step at the time. When Yellen met Treasury Secretary Lloyd Bentsen at his home outside San Diego - while Akerlof waited outside in a rental car - she came armed with examples of the research insights she could bring to policymaking.

Yellen was the rare Fed official to challenge Greenspan and succeed. In 1996, she marshaled academic research, including a paper she had encouraged 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.

After she returned to the board in 2010, Yellen built internal support to formalize this view by establishing a 2 percent target for annual inflation.

In a related debate in 1995, Yellen argued that reducing high unemployment should sometimes be the Fed's highest priority, even above holding down inflation. The bitter aftertaste of the 1970s, when the Fed let inflation soar as it sought lower unemployment, had rendered such views all but sacrilegious for more than a generation, but Yellen argued that the Fed had allowed the pendulum to swing too far.

"To me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target," she said. She would make a similar argument last year as she built support for the Fed's December announcement that it would tolerate projected inflation as high as 2.5 percent in the service of reducing unemployment.

In the mid-1990s, however, both concerns - that inflation would fall too low or that unemployment would rise too high - were purely theoretical. Indeed, unemployment had fallen to such a low level that many Fed officials had begun to worry that a rise in inflation was inevitable.

But in a 1996 memo that Greenspan gratefully distributed to the policy-making committee, Yellen articulated the case he had been trying to make: The Fed could afford to keep rates low because the economy was changing. Productivity was increasing even as global competition was suppressing the ability of workers to bargain for wage increases.

This record has led some critics to charge that Yellen is insufficiently committed to price stability.

"I think she's just entirely too easy money," Julian Robertson, the noted investor, said Monday on CNBC, arguing that Yellen's tolerance of inflation could lead to excesses like the run-up in house prices that led to the financial crisis. "I think we've got to remember that we're not very far from the last bubble bursting."

Yellen was less successful in influencing fiscal policy during a two-year stint as the head of Clinton's Council of Economic Advisers. A careful thinker who likes to consider issues from many sides, she was not well matched to the work of an internal think tank expected to offer quick commentary on a wide range of economic issues. She also found herself outside the circle of the president's closest advisers.

Peter R. Orszag, then a special assistant to the president for economic policy and later Obama's budget director, said in a recent interview that Yellen had done well in both jobs. However, he 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."

Many of Obama's advisers worked with Yellen in the Clinton administration, and some argued that Summers was better suited to managing crises, including problems that might arise during the Fed's retreat from its stimulus campaign.

J. Bradford DeLong, a Berkeley economist and former Clinton administration official who gave public voice to these views, wrote in August that in "normal times" he would have favored Yellen, but given the weakness of the economy, he favored Summers because "a lot of outside-the-box thinking will be called for."

Yellen returned to the Fed in 2004 as president of the Federal Reserve Bank of San Francisco, one of the 12 branches that conduct research, supervise local banks and participate in setting monetary policy.

The staff economists assigned to give Yellen her first briefing on labor market conditions were already a bit nervous about their new boss, who was by far the most accomplished economist in the room. But they thought she might listen in silence, as the bank's previous president had done.

She waited only one sentence before interrupting.

"Well, wait a minute," Yellen said. "What about this?" And then her hands began to trace a graph in the air.

"The shock on the collective faces of us - it was both freeing and suddenly you're in a different world," recalled Mary C. Daly, now the bank's associate director of research. "Where's Janet going to go? It just raised the game."

Yellen demonstrated considerable economic insight over the next several years. She was the first Fed official, in 2005, to describe the rise in housing prices as a bubble that might damage the economy. She was also the first, in 2008, to say that the economy had fallen into recession. And in early 2009, she warned of an "extended period of stagnation," dismissing concerns about imminent inflation.

Her warnings before the crisis, however, were tentative and inconsistent. "I never said for sure there was a bubble, but that it was a possibility," Yellen said in September 2006. "I guess I was inclined to think maybe there was. But I have seen what has happened in the last year or so, and now I'm more dubious." Moreover, she did not advocate for a change in Fed policy.

The San Francisco Fed also did little to constrain the excesses and abuses of banks under its supervision, including two of the nation's largest mortgage lenders, Wells Fargo and Countrywide Financial. Its performance was no worse than the other regional reserve banks, however. They were all taking orders from the Fed's board of governors, which had issued instructions not to scrutinize the subprime lending arms of banks like Wells Fargo.

Although Yellen had no formal role in financial supervision, she requested monthly briefings and sought to raise alarms in Washington. She did not, however, try to constrain lenders unilaterally. "I honestly don't know if we could have done that," she told the Financial Crisis Inquiry Commission in 2010. "I don't think we felt empowered to do it."

She was still on the sidelines as the crisis began. Fed officials in Washington and New York, led by Bernanke and Timothy F. Geithner, managed efforts to arrest the collapse. But after Obama's election, Yellen knew she could be recalled to Washington. One friend recalled that at a certain point, when the subject came up, Yellen stopped saying, "That's inconceivable," and started saying, "That's all I need now."

In April 2012, Yellen told a New York audience that the Fed had not done enough to stimulate the economy in the aftermath of the Great Recession. Yellen, like most of Fed officials, had underestimated the depth of the recession and overestimated the strength of the recovery. The speech was part of a campaign of many months, most of it waged behind the scenes, to convince her colleagues that the Fed could and should do more.

But some Fed officials were waxing skeptical about the Fed's capacity to provide additional help, or worrying about the potential cost. In the months after the April speech, Yellen's advocacy would be drawn into increasingly sharp contrast with the views of the newest professor on the Fed's board, the Harvard economist Jeremy C. Stein, who began to fret publicly that the central bank's efforts could destabilize financial markets.

Yellen's views have prevailed so far. She is not personally close with Bernanke, but they respect each other and have broadly agreed about monetary policy, according to people familiar with the relationship. Together with a number of allies, they forged a consensus in the fall of 2012 for the Fed to expand both of its principal campaigns to spur job creation: more asset purchases, and an extended commitment to low interest rates.

Last month, despite mounting internal pressure to scale back the bond purchases, Yellen and her allies prevailed again. The Fed surprised investors by announcing that it would postpone any retreat as a renewal of Washington's episodic fiscal crisis once again threatened the recovery.

The Fed's stance has been a disappointment to some observers who believe that stronger action is required to reduce unemployment more quickly, even as it continues to worry those who fear that the Fed has exhausted its abilities.

The inconsistent, sometimes contradictory pronouncements of Fed officials in recent months also have aroused the ire of investors who find the Fed's new transparency more confusing at times than its former obfuscation.

Yellen has largely avoided public comment since June, seeking to avoid any impression that she is campaigning for Bernanke's job. It seems likely that she will next speak at a confirmation hearing later this year.

But her views have held remarkably steady over the last three decades: When unemployment is high, the Fed has an obligation to try.

Returning to Yale in 1999, Yellen summarized the lesson she had learned from Tobin and carried with her into public service.

"Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not," she said. "Do policymakers have the knowledge and ability to improve macroeconomic outcomes rather than make matters worse? Yes."

© 2013, The New York Times News Service
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