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TALKING THE TALK
Markets will be looking to Yellen for clearer communication about where Fed policy is heading, after the central bank’s failure to roll back stimulus at its September meeting caught many investors on the back foot.
At her first policy meeting as the Fed’s No. 2 official, Bernanke tapped Yellen to lead a push to fine-tune the central bank’s communications to ensure its policy messages got through.
It was not her first such assignment: in 2007, she helped revamp the Fed’s economic forecasts, making them a more frequent quarterly affair and extending their horizon to three years to improve their usefulness as guideposts on the likely policy path.
In late 2012, Yellen helped push the Fed’s guidance even further by backing a controversial idea to tie interest rates to certain economic thresholds. Specifically, the Fed vowed to hold rates near zero at least until the jobless rate fell to 6.5 percent as long as inflation did not exceed 2.5 percent.
That would allow investors to automatically adjust their rate hike expectations based on economic data, she argued.
Yellen has been credited with seeing the dangers of the housing bubble earlier than some of her colleagues, although her warnings came too late to shield the economy from its deepest recession since the Great Depression.
“In terms of risks to the outlook for growth, I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector,” she said at a meeting in June 2007, warning there was a risk of further significant deterioration.
And yet Yellen underestimated the risks. In October 2007 she told her colleagues that she believed the Fed had “roughly neutralized the shock” from the collapse of the subprime mortgage market by cutting interest rates the month before.
The Great Recession began two months later, setting the stage for the Fed’s unprecedented bond-buying and increasingly detailed interest-rate guidance to return the economy to health.
With the labor market in slow-motion recovery, one of Yellen’s most critical and delicate tasks will be to guide the policy-setting Federal Open Market Committee as it tries to wean markets off the Fed’s bond-buying stimulus.
“I think I am as committed to price stability and the attainment of price stability as any member of the FOMC,” she said in March 2010. “When the time has come, am I going to support raising interest rates? You bet. I don’t want to see inflation pick up.”