After serving as a Fed governor from 1994 to 1997, as president of the San Francisco Fed from 2004 to 2010, and as Fed Vice-Chair for the past three years, Yellen has emerged as one of the central bank’s intellectual leaders. She talked Alan Greenspan out of targeting zero percent inflation, because it would have increased the odds of falling into a liquidity trap (like we have now), back in 1996. She was one of the first to warn about the risk of the shadow banking blowup and housing slump setting off a credit crunch back in 2007. And she’s been one of the architects of the Fed’s unconventional policies today.
Now this is faint praise indeed. On the first point, O’Brien is crediting Yellen for talking Greenspan out of doing something that would have landed us right where we are anyway (i.e. in a liquidity trap). That’s like crediting William Jennings Bryan for talking Woodrow Wilson out of risking US entry into World War I.
On the third point, O’Brien is crediting Yellen for designing the very policies that have delivered this toiletbowl economy for the last 5 years. May I have another, sir?
Now the second point at least looks good, prima facie. You’re probably imagining Yellen in a Fed meeting in, oh I don’t know, February of 2007, pounding the table and saying, “We are on the verge of the worst crisis since 1929! For the love of Pete, Benjamin, we need to act now!!”
Or, you could follow the link, and see that it’s a Fed meeting that occurred in December of 2007. Here’s Yellen’s demonstration of why she’s the right woman for the job:
At the time of our last meeting, I held out hope that the financial turmoil would gradually ebb and the economy might escape without serious damage. Subsequent developments have severely shaken that belief. The bad news since our last meeting has grown steadier and louder, as strains in financial markets have resurfaced and intensified and as the economy has shown clear signs of faltering. In addition, the downside threats to growth that then seemed to be tail events now appear to be much closer to the center of the distribution. I found little to console me in the Greenbook. Like the Board staff, I have significantly marked down my growth forecast. The possibilities of a credit crunch developing and of the economy slipping into a recession seem all too real. [Bold added.]
(UPDATE: It just occurred to me, that the recession officially began in December 2007. So Matt O’Brien is proudly linking to a Fed meeting in which Janet Yellen proves that she is able to sense a recession coming only shortly after it already started.)
In contrast, here’s what I said, in an online article that ran a few months earlier (and actually this was taken from a private report I did for a bank in the summer of 2007):
Looking back at the chart above, we can see why the worst may be yet to come. In (price) inflation-adjusted terms, the early-2000s levels of the actual fed funds rate is the lowest since the Carter years. And many readers may recall the severe recessions of 1980 and 1982 that followed that period.
From 2001–2004, the Fed kept (real) rates at the lowest they’ve been since the late 1970s. One of the consequences that has already manifested itself is the housing bubble. But a more severe liquidation seems unavoidable. The recent Fed cut may postpone the day of reckoning, but it will only make the adjustment that much harsher.
(The title of the above article was, “The Worst Recession in 25 Years?” but I don’t remember if I picked that or not.)
Obviously I’m biased, but I’d have to say that my hedged statement was a lot more accurate than Yellen’s hedged statement. (Full disclosure: I foolishly ignored Austrian business cycle theory in a post in January 2007 when I made fun of Peter Schiff’s doomsaying. My bad.)
Now Matt O’Brien would laugh at my recession call, because it’s based on this wacky Austrian notion that interest rates have anything to do with the business cycle. O’Brien quotes the following passage from Larry Summers:
[SUMMERS:] However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to undertake with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative real interest rate. There is also the question of whether extremely low safe real interest rates promote bubbles of various kinds.
Then O’Brien comments:
In other words, he [Summers] thinks the Fed pushing down real interest rates might only push companies to make bad investments they otherwise wouldn’t make. It’s a very Austrian view of things — the idea that pushing interest rates “artificially” low makes businesses make mistakes.
This is not good. Now, there are plenty of people who think QE is going to turn us into Zimbabwe or inflate the mother-of-all-bubbles or just bail out the banks, but none of those people should be running the Fed.
Yes that’s right, Summers thinks that when it comes to the economy, it’s not just how much businesses invest, but also what they invest in. You would think this would be an obvious point, but instead he is mocked for it (by Scott Sumner too).
On the one hand, I can’t believe that it’s dismissed as crankish Austrianism to think that businesses need to invest in the proper channels, to have a sustained recovery. On the other hand, it’s job security.