Yellen and the Fight for the Fed

The media has paid little attention to the impact a new chair could have on a long-running internal struggle.

A long, quiet struggle has been going on at the U.S. Federal Reserve under the surface of the country’s political consciousness. It gets mentioned from time to time in the media, but seldom does it get explained with any clarity for average followers of the news and hardly anyone pays much attention. Indeed, it seems largely ignored now as President Obama struggles with his task of choosing the next Fed chairman. But, with Harvard professor Larry Summers out of the running and Fed Vice Chairman Janet Yellen the new frontrunner, this quiet struggle may be heading into a significant new phase.

The struggle is focused on how the central bank deals with its so-called dual mandate established by the Full Employment and Balanced Growth Act of 1978, otherwise known as the Humphrey-Hawkins Act (or HH). This legislation set for the Fed the corollary goals of maximum employment and price stability. The problem is that these goals often are in conflict. An ardent pursuit of price stability, for example, can damage national employment prospects, as happened in the 1980s when Fed chairman Paul Volcker squeezed rampant inflation out of the economy at the cost of a serious recession. Similarly, many people believe the current Fed chairman, Ben Bernanke, is generating future inflation with his rampant money-generating policies called "quantitative easing," designed to address the country’s persistently sluggish job market.

This trade-off conundrum is at the heart of all Fed policymaking, and hence the president’s looming selection of a new Fed chief could have profound consequences on the direction of the country’s monetary policy. And yet the coverage hasn’t focused much on this aspect of the matter.

The New York Times informs us that there were tensions between Yellen and Gene B. Sperling, head of the National Economic Council, when both were advisers to President Bill Clinton in the 1990s. She has clashed also, the Times wants us to know, with Daniel Tarullo, a Fed governor with ties to the Obama camp. But the paper doesn’t tell us what those tensions were about, which renders them meaningless. The Times says that Yellen, as a professor at the University of California at Berkeley, "attacked the dogma of efficient markets" and advocated market regulation, which tells us a little more (though some might quibble with the idea of efficient markets being a "dogma").

The Times article adds that she played a central role "in shaping what has become the conventional wisdom that central banks, for the sake of job growth, should seek to moderate rather than eliminate inflation." This sentence betrays a level of journalistic carelessness bordering on ignorance. First, no one of consequence has advocated a target of zero inflation; second, in today’s world of low inflation, the issue isn’t whether to moderate it but whether to juice it up and by how much; and what is described here certainly does not represent any conventional wisdom, in part because it doesn’t make sense and in part because the Humphrey-Hawkins debate is ongoing and is not in any way settled.

So let’s review this Humphrey-Hawkins conundrum as a way, perhaps, of understanding what’s at stake in Obama’s decision. Even before passage of the 1978 legislation, members of the Federal Open Market Committee, the Fed group that makes decisions on interest rates and money supply, grappled with the contradictory aspects of the dual mandate. In one FOMC session, Fed Governor Henry Wallich said, "If you contemplate what Humphrey-Hawkins implies, if anybody abroad thought this would be taken seriously, we would be disavowing all our anti-inflation effort." Volcker, then Fed vice chairman, replied, "Well, I agree with that." He added, "It seems to me that we are in a very awkward position."

Then President John Balles of the San Francisco Fed suggested a fresh way of looking at it. After all, he said, "inflation does cause recession, and recession causes high unemployment. Therefore, if you want to avoid high unemployment, you avoid high inflation. High inflation, high interest rates, and high unemployment go together and vice versa." As Daniel L. Thorton, vice president and economist at the Federal Reserve Bank of St. Louis, explained in a trenchant analysis in a St. Louis Fed publication, "In effect, [Balles] suggested that the FOMC could argue that they were promoting low unemployment by pursuing price stability. This became a common explanation of how the FOMC fulfilled its dual mandate—by pursuing price stability, it was simultaneously pursuing maximum sustainable employment."