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Once upon a time, there was a man named Greenspan. In 1987, when the stock market wobbled, he promised Wall Street all the liquidity it needed and followed that up with an interest rate cut. In the 1990s, he kept interest rates low during a long economic boom, which allowed the technology bubble to inflate to dizzying heights. As a direct response to the September 11 terrorist attacks in 2001, he again lowered rates and kept them low as house prices surged.
There’s a term for this: easy money. But few people dared to utter it while the Maestro (as Greenspan was known) ruled the Federal Reserve. As not only a Republican but also a one-time defender of the gold standard, Greenspan could hardly be accused of debasing the currency. Instead, he was hailed as the greatest central banker in history and reappointed by four different presidents. The five times Greenspan was confirmed as Federal Reserve chair, he pulled in at least 89 votes—twice receiving unanimous support.
Earlier this month, Janet Yellen was confirmed to take Greenspan’s old job with only 56 votes—the slimmest margin in the 100 year history of the Fed—despite having served as vice chair of the Federal Reserve Board, president of the San Francisco Fed, and chair of the Council of Economic Advisers. This week, she will formally take up her position, becoming the first woman to occupy the top slot. But, why was her victory so slim? Because, according to her opponents, Yellen believes in easy money, which will lead to inflation, national decline and the end of Western civilisation.
What’s going on here? Yellen isn’t some kind of radical: like everyone else, she agrees that the Federal Reserve should try to keep inflation under control. Yes, the short-term interest rate is zero, but inflation is historically low—the Core PCE price index is up only 1.0 per cent over the past year—while unemployment is persistently high.
Instead, it’s all about politics. Alan Greenspan could pump up two booms with easy money because the conservatives who might complain were seduced by his libertarian ideology. With the economy stagnant and inflation nonexistent, Janet Yellen is under fire for supporting easy money because interest rates and the Fed balance sheet have become an ideological battleground, elevated to a moral issue by resurgent conservatives clamouring for a return to the gold standard.
Indeed, although the politicians and markets are fixated on the question of quantitative easing and “tapering” (that is, how many fewer bonds will the Fed buy each month?), monetary policy is no more complicated today than in the Greenspan era. Fundamentally, Yellen’s job is to use a handful of levers—buying Treasury bills, buying longer-dated bonds, and talking—to try to influence the supply of credit in the economy. In addition, however, Yellen has two important jobs that Greenspan didn’t have (or ignored).
The first is financial regulation, which was not historically a high priority at the Federal Reserve—until the financial crisis. With the passage of the Dodd-Frank Act in 2010, the Fed is now the United States’ most important financial regulator because it alone has the power to constrain systemically important financial institutions (SIFIs)—that is, the megabanks that are so large, complex, or poorly managed that they pose a threat to the global financial system. Among other things, the Fed can impose higher capital requirements and lower leverage limits on SIFIs, put them through periodic stress tests, and force them to take corrective action if they fail those tests.
This matters because, more than five years after the crisis, the financial system remains more vulnerable than ever to the risks posed by large, complex financial institutions. Banks like JPMorgan Chase, Citigroup, and Bank of America are larger than ever before, face trivially low capital requirements, and—if recent headlines are any indication—are no better managed than when they were buying their own toxic collateralised debt obligations. With its enhanced powers, considerable staff expertise, and relative independence from political pressure, the Federal Reserve is the one agency that might be able to rein these banks in before they cause the next financial crisis.
The other new job is protecting the US economy from politicians in Washington. Despite the year-end compromise that kept the federal government running, there are plentiful opportunities for budgetary showdowns, beginning with the need to raise the debt ceiling in a few months—especially with Republican congressmen hoping to show a hard line in an election year.
As the most independent actor in Washington, it is Yellen’s job to convince the world that the United States, the Treasury Department in particular, remains a sensible place to invest money. In addition, with Republicans steadfastly seeking spending cuts, Congress seems likely to deliver more austerity, not less, over the next few years. If the economy is to have any chance of reaching its potential and reducing unemployment, the Federal Reserve will have to respond with accommodative monetary policy—more easy money, that is.
During the heyday of the “Great Moderation,” Alan Greenspan made central banking look both technocratic and easy: keep interest rates low, bail out the financial system occasionally, and mumble incoherently every six weeks. We are still suffering the consequences. Today, Janet Yellen takes over a job that is much more difficult because it is now inescapably political. Shrugging off inflation hawks is one challenge. Facing up to powerful big banks is another. And protecting the economy from crisis politics in Congress is another. Yellen’s economic credentials are impeccable. Let’s hope she has the backbone to go with it.
