Paul Solman: Just 20 years ago, the NewsHour (then “MacNeil/Lehrer”) ran a meeting of the Federal Reserve. Wednesday marks the end of the Fed’s two-day Open Market Committee meeting, after which chair Janet Yellen will hold her first press conference.
Okay, ours was only a mock meeting, staged to show how the Fed worked, but it was held at the New York Fed and featured an array of former governors of the Fed, who had all participated in Fed meetings and voted on decisions to tighten or spur the economy by adjusting the nation’s money supply.
Watch our simulation of the Fed’s Open Market Committee meeting below.
One of the governors who participated was Richard Syron, then president of the Boston branch of the Federal Reserve. He later went on to a career in the private sector as CEO of Thermo-Electron and the American Stock Exchange before agreeing to run the Federal Home Loan Mortgage Corporation, aka “Freddie Mac,” a job that proved as thankless as it was thorny. He was let go when Freddie came under government conservatorship.
Syron is now adjunct professor of finance at Boston College, his alma mater. Wanting to re-run the Fed meeting we engineered 20 years ago — not much has changed, I’m told — and put the new Fed chair’s challenges in historical perspective, I asked Dick to write something for Making Sen$e on the occasion of the first FOMC meeting under Yellen’s chairmanship.
On Dec. 16 the Federal Reserve celebrated its 100th anniversary with a ceremony that brought together all current and most living members of the Federal Market Open Committee (FOMC), the Fed’s primary policy-making group. Most notably in attendance were Fed ex-chairmen Paul Volcker and Alan Greenspan, its recently-departed chairman Ben Bernanke and its current chairwoman Janet Yellen.
Yellen, who became the first vice chair to become chair on Feb. 1, presides over the first FOMC meeting, which concludes Wednesday with her press conference. The convergence of these events makes this a good time to consider the challenge she faces in the context of her recent predecessors’ legacies.
By and large, the Fed has been fortunate in having chairs whose personalities and skills matched the needs of the times in which they served. However, like all economic policymakers, they were fallible; for example, none foresaw the pending severity of the housing collapse and the economic crisis of 2008.
In the mid to late 1970s, the United States was suffering from seemingly ever-increasing inflation. This inflation was occasioned by a confluence of events: a dramatic increase in the price of oil brought on by the Organization of Petroleum Exporting Countries (OPEC), growing Federal deficits (in part, a legacy of Vietnam) and probably, too lax a monetary policy. To deal with this brewing economic storm, President Jimmy Carter appointed Paul A. Volcker, then president of the New York Fed, as chairman of the Board of Governors of the Federal Reserve in August 1979.
At the time, many thought the seemingly inexorable increase in inflation could not be reversed. There was undeserved skepticism the U.S. would ever again see home mortgage rates in the single digits, for example. Volcker didn’t believe this.
He made a dramatic break with the past by adopting a new regime for monetary policy. Volcker decided that instead of focusing on interest rates as it had historically, the Fed should conduct monetary policy on the basis of the amount of money in circulation — the monetary aggregates. He was able to convince the FOMC to go along with him. Interest rates soared as a result with the prime rate rising to over 20 percent. The housing and auto sectors were particularly in shambles. The country suffered from the worst recession since World War II.
Volcker had served in senior positions for five secretaries of the Treasury and had a deep understanding of financial markets. As a result, he had a strong intuitive sense of how much monetary restraint the economy could take without collapsing. A great many people including many elected officials thought he pushed too hard. However, perhaps Volcker’s most important personal characteristic was a cast iron backbone that enabled him to carry through what was, at the time, a deeply unpopular policy. The result was a return to price stability. This established the foundation for a period of economic growth that, with some relatively mild disruptions, lasted almost a quarter of a century.
Volcker was followed by Alan Greenspan, who was appointed by President Ronald Reagan in August 1987. Greenspan, highly intellectual, is a true master of the workings of the economy. He has a probably unparalleled understanding of economic statistics, developed in his time as an economic consultant to many of the country’s largest companies. He has a broad familiarity with economic policymaking, having served as President Gerald Ford’s chairman of the Council of Economic Advisers.
Changes in the financial system led the Federal Reserve to drop its experiment with focusing on the monetary aggregates, and it resumed setting monetary policy on the basis of interest rates. Because of Greenspan’s deep understanding of the economy, he was able to judge the impact of small changes in rates. He orchestrated a monetary policy that allowed the economy to operate at optimal levels without reigniting inflation. His deft handling of monetary policy earned him the sobriquet “Maestro Greenspan.” He was appointed by four different presidents and was the longest serving Federal Reserve chairman. Under his tutelage, the economy enjoyed a prolonged period of economic growth widely known as “the Great Moderation.”
However, this success may have led many central banks to believe the economy was more inherently stable than it was. This was a worldwide phenomenon. In the United States, Greenspan, deeply philosophical, was strongly skeptical about the efficacy of financial regulation. He had a very strong belief in unfettered markets. Partially as a result, he may have been too sanguine about the ability of the financial system to avoid booms and busts. Like other economic policymakers, he failed to foresee the building excesses that led to the economic crisis of 2008. Admirably, in a speech at the Council of Foreign Relations and later in his recent book, he acknowledged he never saw the crisis coming and that his belief in market self-regulation may have been too optimistic.
Greenspan was succeeded by Ben Bernanke, whom President George Bush appointed in February 2006. Bernanke had been chairman of the Council of Economic Advisers immediately before becoming Fed chair. Bernanke had spent most of his professional life as a professor of economics at Princeton where his chief scholarly interest was the Great Depression. It would be hard to find someone whose lifelong interest melded better with the challenge the Federal Reserve was beginning to face.
Bernanke thought the financial disruptions from the crises of 2008 had the potential to be worse than the impact on the financial system of the Great Depression. Accordingly, he was willing to consider a wide range of extraordinary measures by the Fed to support the financial system. These included effectively guaranteeing JPMorgan’s investment in Bear Stearns as part of the transaction in which they acquired that company and the rapid conversion of many investment banks to bank holding companies, giving them access to the Federal Reserve’s liquidity facilities.
Perhaps most famously, Bernanke fostered the Federal Reserve’s quantitative easing program for injecting funds directly into the financial system and the mortgage market in particular. Many of these steps were unprecedented. He also brought unprecedented transparency to monetary policy, indicating what the future path of interest rates would be and when the Fed would begin to tighten, dependent on economic indicators such as the unemployment rate and inflation.
In some ways, this was the Federal Reserve returning to its roots of a century ago. The Federal Reserve Act was passed as a response to the Panic of 1907. Its primary purpose was to prevent booms and busts in the financial market. Monetary policy as we now know it really didn’t begin until 1951.
Arguably Bernanke’s long study of the Great Depression made him aware of the risks the economy faced in 2007 and 2008. This may have made him willing to pursue policies that would at the least have seemed adventuresome by many in the economic community.
However, developments since then have proved we were lucky to have had as chairman someone who was so innovative and even courageous. While he too did not foresee the economic crisis of 2008, he dealt with it when it developed.
Thus Janet Yellen comes to the job with strong histories from her predecessors. Every indication is that she is up to the job, though the challenges are daunting.
Yellen has had extensive experience in economic policymaking and long experience in studying the behavior of the economy. She too served as chair of the Council of Economic Advisers, appointed by President Clinton. She has been a member of the FOMC and a president of the Federal Reserve Bank of San Francisco and a vice chair of the Board of Governors. She is not only the first woman chair of the Fed but the first vice chair to ascend to the chair.
Yellen’s challenge will be to provide enough stimulus to an economy that has been rather lackluster, while at the same time weaning it from some of the Fed’s extraordinary measures. The Federal Reserve has already tapered its quantitative easing from $85 billion a month to $65 billion a month in purchases of bonds. She is likely to continue this taper as well as the increased transparency in monetary policy.
One of the difficulties she will have to deal with is the still comparatively tepid growth in employment. In this, she will be aided by the academic work she has done on the labor market. While there is little the Fed can do about it directly, she will undoubtedly be quizzed about the growing concern about income inequality after the first FOMC meeting she chairs this week.
While the Federal Reserve has no direct control of the labor market, it will be expected to pursue policies supportive of stronger employment growth. Her life will be made more difficult as a result of political gridlock.
Thus Yellen comes to the job of Fed chair at a time of great challenge but also solid promise. All Fed chairs are fallible and captive to the times in which they serve. However, there is every reason to hope that she will continue the Fed’s recent tradition of, by and large, having someone with the right skills and background for her term as chairwoman.
Paul Solman looked back at Ben Bernanke’s legacy at the Fed and got two assessments of his tenure from Princeton’s Alan Blinder and Columbia’s Charles Calomiris.