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Interview with Janet Yellen

Federal Reserve Governor Yellen discusses politics, bank regulation, Fed research and her family's inclination toward economics.

June 1, 1995

Interview with Janet Yellen

When Janet Yellen was appointed to the Board of Governors last summer, she brought academic credentials from some of the best schools and a long list of published articles, and her analytical talents were praised as "second to none" by one senator. However, while she has made her mark in her new position as a central banker, she has also earned another reputation at the Board—she is considered among the most approachable of the governors.

Yellen's effort to interact with the staff not only reflects her nature, but also the value she places on talking with staff about all sorts of issues. "I enjoy hearing the details," she says in the following interview. "I don't want to just see the bottom line, the summary."

That attitude is reflected in Yellen's comments regarding monetary policy, in which she not only stresses the importance of stable prices, but also the need to focus on more than just numbers: "Why are we in this business? It seems to me that it's to promote the well-being of American households. That's what it's all about."

On the following pages, Yellen also discusses politics, bank regulation, Fed research and her family's inclination toward economics.

Region: As a Fed governor, you seem to have a low public profile. Is that true and if so, is that by design?

Yellen: Communicating with the public about the state of the national economy and explaining the rationale for monetary policy is an important part of a governor's job. Most Americans understand very little about the Federal Reserve and how it carries out its duties, and I think there is a real need for public education. I have given quite a few speeches, primarily concerning the economic situation and monetary policy, and have talked about these same topics with the press, on the record. So in that sense, if I have a low public profile, it's not intentional.

But frankly, one of the more difficult aspects of this job is trying to strike the right balance when it comes to talking about the current economic issues. Markets hang on one's every word, sometimes reading too much into what one says and quoting things out of context. During the last several months, for example, I have consistently voiced concern that there are two risks as we go forward: On the one hand, there is the risk that we have not tightened enough, so that inflation may rise; and, on the other hand, there is the risk that we have tightened too much, and the economy may end up slowing more than we would ideally like. I am concerned about both of these risks. But I often find that one or the other but not both of these statements is quoted, giving a highly biased sense of my overall outlook. There are times, when markets are particularly unsettled, that it simply makes sense to avoid commenting on a particular issue, like the movement in the dollar, to avoid adding to the turbulence. In this regard, discretion is the better part of valor.

Region: In your Senate confirmation hearing you pledged to craft a monetary policy geared toward maximum employment, stable prices and moderate long-term interest rates. Do you find any of those goals paradoxical?

Yellen: Those are the goals enunciated in the Federal Reserve Act, which is the Fed's primary legislative mandate. I might have phrased the directive a bit differently had I been charged with drafting it, but the goals are by no means paradoxical to me, because each goal reflects a sensible social concern—with inflation, with jobs and with the cost of borrowing—aspects of economic performance that monetary policy affects.

The problem with the mandate is that it gives no guidance to the Fed about how it should call tough tradeoffs if not all of the goals are simultaneously attainable. Like most mainstream economists these days, I think the "natural rate theory" fits the data for the United States reasonably well, suggesting that there is, to a first approximation, no long run tradeoff between inflation and employment. In this sense, there are certainly limits on what the Federal Reserve can accomplish through monetary policy. While I would not push the theory too far, because fashions in economics change, I would agree that the Fed probably cannot achieve permanent gains in the level of employment by living with higher inflation. But the Federal Reserve can, I think, make a contribution on the employment side by mitigating economic fluctuations—by stabilizing real activity. I thus translate the "maximum employment" proviso of the Federal Reserve Act as a mandate for the Fed to lean against the wind, stimulating the economy when the economy is in recession or unemployment is clearly in excess of the NAIRU (the non-accelerating inflation rate of unemployment—the minimum rate of unemployment consistent with stable inflation), and restraining the economy through tighter policy when economic activity is pushing against the limits of capacity with inflationary implications. This is what the Federal Reserve has traditionally done and it is what I think the Fed should continue to do. There is no tradeoff in my view between this stabilization objective and the objective of price stability. We can achieve whatever inflation rate we desire, on average, while acting to stabilize the economy.

Turning to the goal of moderate long-term interest rates: Long-term nominal interest rates depend on the long-term real rate, which reflects the saving and investment decisions of households, firms and governments, and is largely outside the Fed's control, and inflationary expectations, which are very much in the Fed's purview. If the Fed is successful in attaining price stability it will contribute as much as it can to the goal of moderate long-term nominal interest rates.

Region: At that same hearing, you said, "I hope to keep my eye on the people behind the numbers." With monetary policy such a blunt instrument, can you really do that?

Yellen: I made that comment in response to a statement by [then] Sen. Riegle about rising wage inequality in the United States. He pointed to one of the most disturbing and fundamental long-term secular shifts in the American economy that we have seen in recent decades. American workers have faced serious difficulties in the labor market since the first oil shock in 1973. Since that time, the pace of productivity advance has slowed for reasons which are still not understood, lowering the rate at which living standards have advanced. Even more disturbing, wage inequality has risen, with young men with high school diplomas, for example, experiencing real wage losses of roughly 25 percent from 1971 to 1988. These trends have frustrated the aspirations of many Americans.

Sen. Riegle pointed out that the decisions of the Federal Reserve can add to the already considerable problems of working Americans by raising unemployment, making it hard for them to support themselves and their families, to land a good job when they leave school, or switch jobs if they become dissatisfied with their current employment. I agree. That's why I think stabilization policy is important—to avoid huge swings in unemployment. When you have the kind of recession we had in 1982 and 1983, for example, you can see the visible toll it takes on households. Perhaps because the causes and consequences of unemployment have been a focus of my research, I consider it easy to remain mindful of the people behind the numbers. In order to avoid high unemployment we must be careful not to push the economy below the NAIRU, allowing inflation to rise and to become embedded in expectations. Because when that happens, it takes a period of above normal unemployment to lower inflation. That's the painful lesson of the '70s. Even when it comes to inflation we have to remember that prices per se do not affect social welfare. Inflation matters because of its repercussions on a country's economic performance, which in turn affects the welfare of individuals. Why are we in this business? It seems to me that it's to promote the well-being of American households. That's what it's all about.

Region: An unidentified Fed official was quoted in the New York Times saying, "When the time comes to move in the other direction and ease interest rates ... the Blinder-Yellen analysis might be part of that change." Tell us about the Blinder-Yellen analysis: real or perceived?

Yellen: I believe that the unidentified official may have been referring to my concern, which I voice routinely in interviews and speeches, with the implications of lags for the appropriate conduct of monetary policy. One of the time-honored truths of macroeconomics is that monetary policy operates with long and variable lags. This implies that any policy change put into place at a given time will continue to affect the economy for a very long time into the future. The typical econometric model, suggests, for example, that less than half of the impact of a monetary policy change occurs during the first year. The Fed, for that reason, has to be forward looking, implementing policies well in advance so that they will begin to impact the economy at the time they are needed.

Starting a year ago February, the Fed wisely began tightening monetary policy, not because restraint was needed then—after all, inflation was falling and there was still substantial economic slack—but because it was convinced that without laying the groundwork, the economy would end up overheating, and inflation would rise. It has taken a long time for those policies to have a discernible impact. It is only during the last few months, I think, that their impact on the interest-sensitive sectors—autos, housing, consumer durables—has become apparent. This is not really surprising, because the policy tightening averages only eight or nine months in age. In the meantime, one has to wait, without seeing much happen, and during that waiting period, the assumption that the restraint in the pipeline will eventually make itself felt requires an act of faith, based on past experience. It's all too easy to lose faith that the policy will work and to conclude that, for any of a number of reasons, past actions just aren't having the expected impact. The consequence is that monetary policy always faces the possibility of oversteering—tightening too much when demand is growing too quickly and later loosening too much when the economy has slack—and getting the timing all wrong. That's why Milton Friedman warned that monetary policy can destabilize the economy.

Perhaps the unnamed Fed official drew the conclusion that one day, when the time eventually comes to ease policy, the need for such actions will not be apparent from current economic indicators but instead will be based on a forecast of where things are headed. Indeed, just as policy began to be tightened at a time when inflation was falling and there remained excess capacity, it is conceivable, using symmetric reasoning, that it will be right to begin loosening even with the economy operating beyond potential or with inflation rising.

Region: And in Blinder's case ...

Yellen: I can't speak for him, but I imagine that he would agree. We've both given speeches in which we've made these points. This line of reasoning leads to the idea that policy should be altered conservatively, moderately. We should be careful not to overdo policy swings. In the extreme, Milton Friedman would have us do nothing. He would like the Fed to keep the dials fixed. But I certainly wouldn't go that far, and I don't think Blinder would either.

Region: When you were appointed to the Board of Governors by President Clinton, there was a quite different political circumstance than exists today. Has the change affected your role as a governor?

Yellen: I don't think it's affected my role as a governor. Politics play virtually no role at all in the life of a Fed governor, because, as you know, the Federal Reserve is an entirely apolitical institution. With a 14-year term, a Fed governor has both the luxury and duty to focus on the long term and to ignore politics.

Politics only matters insofar as it affects Congress' agenda with respect to the banking industry and the Federal Reserve. In that regard, the political changes do have implications both for the Fed and the banking industry. As you undoubtedly know, Glass-Steagall reform is one of the top priorities of Jim Leach, the chairman of the House Banking Committee. Senator D'Amato, chairman of the Senate Banking Committee, is also proposing reform in this area, although the two committee chairs would approach such reform in different ways. The Board is committed to the view that banks should be allowed to engage in securities underwriting, as long as this occurs with appropriate safeguards. We don't think this activity is particularly risky, and there would be benefits both for the industry and for consumers. Thus we welcome Congress' interest in Glass-Steagall reform and have testified to this effect. We are hoping for legislation in this area.

Regulatory burden is another area which is receiving a great deal of attention in the new Congress and again, this is an area of concern both to the Board and to the banking industry. Comprehensive regulatory reduction bills geared to banking have been introduced in both houses of Congress, and I am sure that the Board will support many of the provisions of the bills as well as the overall thrust of the legislation. It's a bit early to know just what will happen with this legislation.

Region: As a follow-up question, compared to most other political appointments, your political resume is virtually non-existent. It seems that you were selected to serve on the Board on some basis other than political. What do you think?

Yellen: Correct. I have no political resume whatever. I'm a Democrat and I supported Clinton but I doubt that was the reason for my appointment. I assume that I was appointed for my expertise in economic analysis. I consider myself a pragmatic, mainstream economist with a strong policy orientation. I have spent most of my professional life teaching and conducting research on labor markets and international issues in academic settings and also, for a time, as an economist in the Division of International Finance here at the Board. Having taught on the faculty of a business school for the last 14 years, particularly in the fields of international business and economics, I think that I have also developed a good feeling for the ways in which the economic and regulatory environment impacts businesses that are trying to compete in the global economy. I assume that the president believed I would have the right toolkit to analyze the issues confronting the Board, both with respect to monetary policy and also in connection with regulatory issues.

Region: Before becoming a governor, you and your husband [George Akerlof, professor, University of California, Berkeley] collaborated on economic studies. What was the nature of your work?

Yellen: We've done a lot of work together. We are probably best known for our joint work on wage and price rigidity. A central puzzle in macroeconomics is why wages and prices exhibit so much inertia. We probably wouldn't need monetary policy at all if wages and prices at the aggregate level adjusted very rapidly to clear markets. But I think most people have arrived at the conclusion that wages and prices just aren't that flexible. The question is: Why not? My husband and I have written papers that analyze this issue, focusing on the possibility that the payoff to individual firms and workers from adjusting wages and prices may be so small that they just don't bother—or if they do, they adjust slowly. And yet, even though such inertial behavior is not very costly for individuals—we call it "near rational"—it adds up to produce major costs at the aggregate level.

We've also focused a great deal on unemployment. Unemployment is a puzzle for any economist. Why is it that labor markets seem not to clear? Why is it that firms don't cut the wages of their current employees when there are people outside their gates lining up to fill out applications, offering to work and willing to accept wages that are lower than the going pay of the current employees?

We're associated with a school of thought known as "efficiency wage theory," which takes seriously the idea that firms' wage policies impact the productivity and morale of workers and that firms constantly take those impacts into account in setting and changing wages. Firms don't just try to pay as little as possible to get the needed bodies on board; when there is unemployment, they ask themselves how wage cuts would affect the behavior of the employees. Would they quit or feel dissatisfied and work less hard on the firm's behalf if they feel that wage policies are unfair?

My husband and I have also studied alternative measures of unemployment. There was a period, during the late '70s and '80s, when the Phillips curve seemed to be shifting. Inflation was higher than one would have expected, looking at the traditional indicators like the unemployment rate. We developed an alternative measure of unemployment, based on recall data, to gain some insight into why the Phillips curve had shifted.

We also did a large research project on German unification that appeared in Brookings Papers on Economic Activity in spring 1991. The paper attracted quite a bit of attention, because we analyzed data on East German firms and forecast that, given the terms on which unification had occurred and the subsequent behavior of wages, only 10 percent of East German employment was in firms which could cover their costs once they were forced to compete in international markets. We developed a flexible wage subsidy plan with built in sunset provisions to deal with the problems which were certain to ensue. Our plan was vigorously debated, but not ultimately adopted. More recently, we have focused on American social problems including crime and the breakdown of the family.

Region: Are husband and wife teams common?

Yellen: They're becoming more common. Actually our closest friends at Berkeley are a husband and wife team who work on macroeconomics, both together and individually. More women these days are waiting longer to get married, and are meeting their respective mates in graduate school or on the job, so it's natural. Women's lives revolve more around the workplace, and that's how many relationships are formed. In fact, I met my husband on the job, here at the Board, at a lunch following a seminar. I was working in the International Finance Division, and he was working in Research and Statistics, on money demand.

Region: What kind of research should the Fed pursue?

Yellen: I believe that the Federal Reserve should have a very broad research agenda, focusing both on basic and applied questions. By allowing our economists considerable freedom to research whatever questions are most intriguing, we attract the very best talent to the Federal Reserve System, and that is the System's greatest strength. There are so many puzzles relating to macroeconomic performance that the potential range of research topics with bearing on monetary policy is enormous: Why did productivity growth slow starting in the 1970s and has it finally increased again? Are there changes in the labor market related to global competition which affect the inflationary process? Why is the American savings rate so low? What explains the volatility of asset prices? We spend our day looking at these asset prices on the screen and trying to interpret what they might mean about how people's expectations are being formed.

What we know from decades of research, and some of the most important papers were written by Fed staff, is that asset prices are simply too volatile. They move much more than is justified by movements in the fundamentals. Why is that? What are the channels through which monetary policy impacts investment and saving? Has the transmission mechanism changed? How can we account for the behavior of exchange rates in general and the weakness of the dollar more recently? The list is endless. In addition, there are so many regulatory questions, where research is useful in the work we do. Fed economists should continue to study, for example, the classic questions concerning structure, conduct and performance in financial markets; to understand the incentives created by deposit insurance and the safety net and so on. There are many questions relating to derivatives and payments system risk, where research is also having a high payoff. For example, research conducted in the Federal Reserve System on the use of banks' internal models to compute capital requirements is leading to innovative approaches to the development of capital requirements oriented toward market risk in bank trading portfolios. My list of good research topics is endless.

Region: Do you make a distinction between Board research and bank research in any way? Is it all just research to you?

Yellen: It's all research to me. I don't see that there's any great difference between what we should be doing at the Board and what should go on at the banks. A lot of the banks, including your own, have outstanding research staff. In Minneapolis, you have promoted and supported very basic research. It's quite interesting, and I think a tribute to your research agenda, that so much of it has ended up in my bookshelf. I don't agree with it all, but it's extremely interesting.

Region: Earlier this year a group of U.S. senators released a list of the 10 worst regulations. Among them were the Truth in Lending Act and the Community Reinvestment Act [CRA]. Do you have any reaction to the list now that you have had a chance to work with these two sets of regulations?

Yellen: Clearly regulatory burden is a big issue for banks. Bank regulations have become quite complex, and I think that many banks, particularly smaller banks, are heavily burdened.

The CRA and Truth in Lending regulations rank high on bankers' lists of burdensome regulations. In both cases, banks have confronted the need for a lot of expensive paperwork and, in the case of CRA, some genuine uncertainty as to what the regulations require. Nevertheless, I think it should be clearly recognized that most of the burden stems from the fact that the Fed is required by law to write rules which insure compliance with legislation which responds to very legitimate public policy concerns. The laws themselves are complex; the statutes often provide for civil liability exposure; and, therefore, institutions can't live with ambiguity in the rules. The consequence is that regulations must be formulated which are unambiguous and therefore complex.

We need to compare the benefits of regulations with the costs that these regulations impose on the business community. In many but not all cases, I believe that the benefits outweigh the costs. CRA is a good example. Before CRA was passed, redlining was a common practice, and some low- and moderate-income communities faced difficulties gaining access to credit. You literally had banks that were taking red pens and putting lines around certain districts of the city where they wouldn't lend. That was their policy—not to lend. And I think that was a problem and it was right for Congress to address that issue. The Community Reinvestment Act made banks think quite hard about how to serve the needs of these communities by devising new approaches—new products tailored to the needs of these areas and new methods for marketing these products. Many banks have discovered profitable ways of serving these often neglected niches. So CRA has had some very valuable effects. But CRA is also burdensome. And, as the regulators have learned over the last several years, streamlining performance measurement in a way which is fair to banks and to the communities turns out to be fraught with hazards. In the case of CRA, I think that the new regulations will offer greater clarity and certainty. There will be streamlined procedures for small banks and clear performance measurement to assure good performance rather than just good process.

Region: Of those hobbies or reading interests or some special projects or family sports, what would be interesting for people to know about you?

Yellen: There is very little that is really interesting. The truth is, if you spent an evening at our house you would probably hear economics discussed over the dinner table. My husband and I work together, we're both economists, and the bulk of our friends are economists. You would eat a diet that is richer in discussions of economics and policy issues than many people would find appetizing. We have one son who is 13, and he has mentioned that he is also thinking of becoming an economist.

We're a close-knit family and we spend a lot of time together. We like to travel; we enjoy going to exotic spots. We prefer not to mix work and play, but instead, to have relaxing family vacations together. We all like to eat and cook.

Region: Any particular style of cooking?

Yellen: We enjoy ethnic food of all types. The range of culinary possibilities in Berkeley is staggering, and that probably fueled our interest. We like to entertain and to cook and my son's interested in cooking too. And having lived in California, where the weather's nice almost all year round, although we're not great athletes, we enjoy hiking and tennis. I'm not ready for a match with the chairman, but I enjoy knocking the ball around.

Region: And the exotic places that you've liked, any that you could mention?

Yellen: We recently visited Kakadu National Park and the outback in northern Australia to see the wildlife and aboriginal art and sand paintings. We also spent time relaxing in French Polynesia—in Bora Bora and Huahine.

Region: Chatting with Board staffers, we learned that you are considered among the most approachable of the governors. How do you plead on that?

Yellen: I plead guilty. I like interacting with people. Wouldn't you expect that to be the norm? I'm not sure why it should be a surprise that a governor would be approachable.

I was a staffer here. I'm an economist. I share the same interests as a large fraction of our staff. I enjoy hearing the details, for example, about the economic forecast. I don't want to just see the bottom line, the summary. I want to track the numbers; I want to keep revisiting the key issues. Is inflation on track? Do the models fit? What are the puzzles? Where are the risks? Why is the dollar declining? And so I interact a lot with the staff around such issues. This is the aspect of the job I enjoy most.

Region: You were spotted up in the cafeteria or someone who looked very much like you, so they say. That's a little uncommon among governors isn't it?

Yellen: It is a bit uncommon, because the Board is a somewhat hierarchical place. I can't frankly tell you why that is. But that's not the way I operate. Eating in the cafeteria with the staff is a pretty good way to learn what people are thinking about, what's on their mind. And I enjoy the interaction.

Region: Betty Friedan, in an earlier interview with The Region, emphasized that economics is the basis for women's progress toward equality. Does that square with your point of view?

Yellen: She's clearly right about the importance of economics to women. Female labor force participation has increased enormously, especially with slow wage growth and declining wages for less educated men. Economics is a central motivator for women.

It seems to me that women have made an awful lot of progress, but they probably remain under-represented, at the highest levels of most organizations, for a variety of reasons. And it's probably going to take a long time to change that.

I've had a lot of opportunities in my life. I don't feel that I've faced discrimination. I've had every chance to succeed and more, and I think that's what all women should have. Things are changing; the playing field is becoming a lot more level. Certainly Betty Friedan is right that economic issues—getting the kind of education and training that's necessary to have a career and to succeed in the workplace, and juggling work and family responsibilities—remain central for most women.

Region: In the past you taught macroeconomics and international economics to MBAs and executives. Of the macroeconomic concepts you taught, which were the hardest to grasp for business people of the present and future?

Yellen: That's an interesting question. Macroeconomics is intuitively harder to understand than microeconomics, since it concerns the interaction of many different markets simultaneously. In the end, macroeconomics comes down to understanding how supply and demand work in the economy as a whole, but it takes some time before MBAs and executives can really understand, for example, the transmission mechanism and how Fed policy affects the economy. The determination of exchange rates and the relationship between trade and capital movements in the international economy are also particularly difficult for students to grasp. But then, although we have a lot of interesting theories concerning exchange rates and trade flows, the reality is that none of them really work, so perhaps its natural for students to be confused.

Region: Back in the '70s you worked at the Federal Reserve as a consultant to the Division of International Finance, and then later as an economist in the same division and now you return. I wonder if you can detect any fundamental differences—excluding those that might come from the current elevated perspective?

Yellen: To me the greatest asset of the Fed is the people. We have a tremendously dedicated staff. I was here in 1977-78; I came back 16 years later and found that most of the people I worked with are still here. They're working just as hard as ever, and there's a really good reason for it. It isn't an accident. It's because the organization is really so well run and the staff feel committed to it. They feel proud to work for the Fed, because this is such a competent, professional and well-respected organization. I feel proud of the organization too; I wouldn't have wanted to come back unless I felt that way.

So have things changed? No, and it's wonderful they haven't changed.

Region: Thank you, Ms. Yellen.

More about Janet Yellen

Most recently, she was the Bernard T. Rocca Jr. Professor of International Business and Trade, University of California, Berkeley; prior to that she was a professor and associate professor at Berkeley.

She has been a lecturer at the London School of Economics, an assistant professor of economics at Harvard, and an economist in the Division of International Finance, Federal Reserve Board of Governors.

Her prior government experience—in addition to her work at the Board—includes service on the Congressional Budget Office's Panel of Economic Advisers and on several review panels for the National Science Foundation. Doctorate, Yale University, 1971; bachelor's degree, Brown University, 1967.

Best known for her work exploring the causes of wage and price rigidity, her macroeconomic research also includes work on unemployment and other wage issues; internationally, she has studied issues concerning exchange rates, as well as German monetary union and the impact on East German reconstruction.

Her papers include "Gang Behavior, Law Enforcement and Community Values," (with George Akerlof), Values and Public Policy, Brookings Institution, 1994; "The Fair Wage/Effort Hypothesis and Unemployment," (with George Akerlof), Quarterly Journal of Economics, May 1990; "Is There a J-Curve?" (with Andrew Rose), Journal of Monetary Economics, July 1989; "Rational Models of Irrational Behavior," (with George Akerlof), American Economic Review, May 1988.