The Senate Banking Committee just voted 14 to 8 to confirm Janet Yellen’s nomination to be the new Chair of the Federal Reserve. She will likely go on to be confirmed by the full Senate.
Much of the coverage has focused on Yellen as a person, when the real story is on the Fed as an institution. Sometimes individuals have profound influence on Fed policy, such as Paul Volcker in the late 1970s and 1980s. Over time, however, the institutional structure of the central bank and the incentives facing policymakers matter more.
The Federal Reserve famously has a dual mandate of promoting maximum employment and price stability. The Federal Open Market Committee, which sets monetary policy, has great discretion in weighting the two policy goals. As a practical matter, the vast majority of the time, full employment receives the greater weight. That is because the Fed is subject to similar pressures as are the members of Congress to which the Fed must report. In the short run, voters want to see more job creation. That is especially true today. The United States is experiencing weak growth with anemic job creation.
Never mind that the Fed is not capable of stimulating job creation, at least not in a sustained way over time. It has a jobs mandate and has created expectations that it can stimulate job growth with monetary policy. The Fed became an inflation-fighter under Volcker only when high inflation produced strong political currents to fight inflation even at the cost of recession and job creation.
The Federal Reserve claims political independence, but it has been so only comparatively rarely. Even Volcker could make tough decisions only because he was supported by President Carter, who appointed him, and President Reagan, who reappointed him. Conventionally defined inflation is low now, so the Fed under any likely Chair would continue its program of monetary stimulus. Perhaps Yellen is personally inclined to continue it longer than might some other candidates. But all possible Fed chiefs’ would face the same pressures to “do something” to enhance job growth, even if its policy tools are not effective.
The prolonged period of low interest rates has made the Fed the enabler of the federal government’s fiscal deficits. Low interest rates have kept down the government’s borrowing costs, at least compared to what they would have been under “normal” interest rates of 3-4 percent.
Congress and the president have been spared a fiscal crisis, and thus repeatedly punted on fiscal reform. They are likely to continue doing so until rising interest rates precipitate a crisis. How long that can be postponed remains an open question.