Yellen earns ‘I’ for ‘incomplete’ on final Fed report card

Janet Yellen announced this week that she will step down from the Federal Reserve Board as soon as her successor to the chair, Jay Powell, is confirmed and sworn in.

She had the option of remaining as a governor, but that was an exceedingly unlikely prospect (only once has a demoted ex-chairman remained on the board). Focus immediately turns to Yellen’s legacy as chairwoman.

{mosads}Yellen took over as chairwoman at the beginning of 2014 with the Fed still going full blast with easy monetary policy. The Fed bought securities at a rapid pace in 2013 and had spent much of that year grappling with market fears that the central bank was preparing to pare back quantitative easing (QE).

In the spring and summer, interest rates surged when then-Chairman Ben Bernanke hinted at tapering purchases (an episode infamously described as the “Taper Tantrum”). Fed officials had suggested a possible September start to the slowing in the rate of purchases but were spooked by the Taper Tantrum and demurred.

Finally, on his way out the door, Bernanke initiated the first step in the tapering of the pace of QE purchases in December 2013.

Thus, Yellen’s first year was easy, as the Federal Open Market Committee (FOMC) mechanically worked the pace of QE down over the course of the year. Once QE ended in October, attention turned to when the Fed would lift its policy rate above zero.

This is where Chair Yellen’s legacy will likely focus, for better or worse. Under Yellen’s leadership, the FOMC chose to drag its heels, holding at zero until the end of 2015 and then hiking only once in 2016 as well. In each of those years, the Fed had come into the year projecting that it would raise rates multiple times only to fail to follow through, deterred by a series of economic and market shocks that spooked the FOMC.

Finally, in what turns out to have been Yellen’s last full year, the Fed has roughly matched its projections for policy in 2017, likely pushing rates up three times (that assumes the widely-anticipated December move takes place). Still, I suspect that Chairwoman Yellen will be remembered for keeping interest rates super-low for the bulk of her four-year term.

In that sense, Chairwoman Yellen leaves office with a grade of incomplete. Some hail her hesitance to raise rates as a stroke of genius, given that inflation has remained below the Fed’s 2-percent target throughout this expansion. Her advocates also point out that her tenure (albeit brief) did not include a recession, unlike her more illustrious predecessors — Volcker, Greenspan and Bernanke.

Others are more critical, noting that the economy is already overheating (with the unemployment rate approaching 4 percent, well below economists’ estimates of what is sustainable) and financial conditions are the most accommodative in years, suggesting an excessively easy central bank policy.

Ironically, I would argue that Yellen leaves an economy to her successor Jay Powell that looks similar in many ways to the situation that Greenspan left when he retired in early 2006. The Fed had raised rates significantly under Greenspan in 2004 and 2005 but had dragged its heels in doing so, creating extremely easy financial conditions that ultimately set the stage for the financial crisis.

Greenspan left office at the beginning of 2006 as “the Maestro,” labeled by one former colleague as the greatest central banker of all time (yes, apparently, there are debates about who is the “GoAT” even among central bankers!).

A few years later, his reputation had taken a massive hit, as it was realized that his policies had helped to create, or at a minimum worsen, the catastrophic events of 2007 and 2008.

Of course, every economic cycle is different, and we can all hope that Yellen’s legacy has a happier ending than Greenspan’s.

Still, the seeds have been sown, and the results for growth, unemployment and inflation, as well as financial conditions, over the next two or three years will tell us whether Yellen’s tenure as chairwoman was a success or a failure.

Stephen Stanley is the chief economist for Amherst Pierpont Securities, a broker dealer providing institutional and middle-market clients with access to fixed-income products.