Janet Yellen’s judgment calls made during the darkest moments of the financial crisis were mostly borne out by subsequent events, transcripts from the Federal Reserve’s 2009 monetary policy meetings published Wednesday show.
That year, as the U.S. economy was shedding jobs by the hundreds of thousands each month and the economy was shrinking at the fastest pace in decades, Yellen brushed off concerns about inflation in advocating greater monetary policy stimulus and warned that the labor market fallout was likely to continue for years.
Yellen’s advocacy of fiscal and monetary policy stimulus during the crisis are well-known. At the time, as president of the Federal Reserve Bank of San Francisco, she publicly compared the U.S. situation to the Great Depression and the deflationary stagnation that afflicted Japan throughout the 1990s.
Economists and historians will debate the steps that the Fed took to counteract the crisis for years to come, but the newly released records of the Fed’s interior deliberations is that the future chairwoman had a realistic forecast of the economy at a time when many did not, and was ahead of the curve in terms of the unconventional monetary policies that the Fed would ultimately embrace.
On a conference call with then-chairman Ben Bernanke in January 2009, with the Fed recently having driven short-term interest rates all the way to zero and ramping up its balance sheet to bail out banks, Yellen noted the need for the Fed to assuage fears that it and the Obama administration would stoke too-high inflation.
“There is growing concern that the Fed is printing money with abandon to stimulate the economy, and the combination of trillion-dollar deficits and trillions of dollars of money creation can have only one outcome in the long run, which is high inflation that debases the currency,” Yellen told the other Fed members on the line.
“Now, I think this reasoning is completely misguided, but it is out there, and I think we need to consider it because it is dangerous for our credibility as an institution,” Yellen remarked. “So I also think we have to say that we are not willing to tolerate very high inflation.”
On that teleconference, Yellen also called for the Fed to set a target of 2 percent annual inflation, a suggestion that was adopted in 2012.
Inflation would turn to mild deflation throughout 2009, with consumer prices dropping 2 percent year-over-year in July. And the rampant inflation feared by many never materialized. Throughout the recovery, consumer prices have risen at below the 2 percent pace the Fed aims to maintain.
At the meeting of the Fed’s monetary policy committee that month in Washington, Yellen warned that “we are in the midst of a very deep and protracted downturn, and I have to squint really hard to see any light at the end of the tunnel.”
Even “with a large fiscal stimulus, it will take many years before the economy returns to potential and economic slack is eliminated,” Yellen said.
At the March meeting, she said her “fear is that we may not even get a modest U-shaped recovery, much less a V-shaped one,” a reference to the shape of economic output growth on a chart. That prediction, shared by other Fed officials, would prove accurate, as the post-financial crisis recovery would ultimately prove to be the slowest of any since the Great Depression.
Yellen cited three factors that would weigh down on the recovery: Other countries were also suffering severe recessions and would be unable to provide an external source of demand; the banking system’s ill health limiting the effect of monetary policy; and the poor state of household and government balance sheets. It would take five years for households to finish shoring up their balance sheets and begin taking out debt again.
At that meeting, Yellen was a strong advocate of the Fed’s large-scale bond purchase plans, now commonly known as quantitative easing.
The next month, after the initial roll-out of quantitative easing, Yellen told Bernanke and company that the best strategy was to ramp up the bond purchases. “I don’t see a reason to keep our powder dry,” she said. “So I prefer to take appropriate, bold action to stimulate the economy sooner rather than later.”
Her advice was not taken — at least not then. After the unemployment rate soared to 10 percent in late 2009 and stayed near that level into 2010, the Fed would ultimately launch a $600 billion bond purchase program now known as QE2. When even that ultimately failed to generate a self-sustaining recovery, the Bernanke Fed, with Yellen as vice chairwoman, would resort to another round of quantitative easing in late 2012 that ultimately expanded the balance sheet to $4.5 trillion before ending in fall 2014.
In August 2009, Yellen predicted that eventually researchers would peg that quarter as marking the official end of the recession. She was not far off, as the National Bureau of Economic Research ultimately said that the recession ended in June 2009.
But as late as December, Yellen expressed concerns that the central bank was underestimating the labor market fallout from the recession.
She noted that her forecasters at the San Francisco Fed were “incredulous” at the Federal Reserve Board of Governors’ projections. “My contacts are more likely to be considering continued layoffs rather than any substantial hiring. Indeed, one of them said, ‘It’s become fashionable not to be hiring,'” she said. Businesses, she said, “remain shell-shocked and traumatized from recent events.”
Throughout the year, Yellen strongly endorsed both monetary and fiscal stimulus. In a public speech back home in San Francisco in January, she said that “it is time to “pull out all the stops” — that is, to deploy both monetary and fiscal policy — to avoid a deep and lingering recession.”
Nevertheless, she was aware that outside critics would perceive the Fed as overreaching, and advocated transparency and clarity about its goals as a response.
“To assuage this concern, it is important for us to emphasize and defend our independence, to express confidence in our ability to tighten monetary conditions when the right time comes, and to stress our determination to maintain price stability,” she said in August.
Those concerns, too, look well-founded in hindsight, with a renewed effort underway in 2015 by Congress to increase oversight and accountability at the Fed.
