Janet Yellen’s farewell speech included a striking counterfactual: massive unemployment might’ve been needed to control inflation. Here’s what she said.
Up close and personal. I have read dozens and dozens of transcripts of Janet Yellen’s comments over the years. My relationship with Yellen goes back to 1994 when she first joined the Fed Board of Governors. Yeah, I have been here for a bit. 😉 Yellen left the Fed briefly to chair President Clinton’s Council of Economic Advisors, taking the reins from Joe Stiglitz, who was one of her academic advisors (who knew). She found her way back to the Fed, becoming the CEO of The Federal Reserve Bank of San Francisco. President Obama nominated her for the role of Vice Chair and ultimately to the role of Fed Chair, succeeding Ben Bernanke. If I ended the story there, it would be impressive at all levels with no doubts about her bona fides as a person of influence on the US Economy. Oh, and along the way, she ran into a chap by the name of George Akerlof in the Fed cafeteria. Akerlof was already on my radar when I was still in short pants, studying Economics at my beloved alma mater Rutgers. Akerlof was a household name in New Jersey Hall for his treatise on… um Lemons. Not the kind of lemons that I referred to in yesterday's note; Akerlof’s lemons were, for example, a bad car. Yeah those. His seminal paper landed him a Nobel Prize. Now, I am doing them both severe injustice by covering their work in just one introductory paragraph, but I think that it should be quite clear that the Yellen-Akerlof’s, Akerlof-Yellen’s, Akerlof’s, or Yellen’s—no matter how you look at it—are noteworthy in the world of economics.
Ok, forget about George for a moment. This is about Janet. She left the Fed after being succeeded by current Chair Jerome Powell, who was nominated by President Trump in his first stint at the White House. Yellen did not stay out of the scene for too long and returned to Washington DC to serve as President Biden’s Treasury Secretary. On this very day, President Trump’s nominee to succeed her, Scott Bessent, will be on Capitol Hill for his big job interview, and his would-be boss will be sworn into office on Monday. That means, in a nutshell, that Janet Yellen is about to get a well-deserved vacation.
Imagine if I could get so lucky to hear from a former finance professor of mine from Rutgers, inviting me to hear Janet Yellen give her final public speech before leaving the US Treasury. Now, I am a member of the New York Association for Business Economics (NYABE), but this event is an invite-only event. Well, as you can probably guess, I did get so lucky! It was a fancy event held at New York’s iconic Plaza Hotel. To get to the ballroom I had to walk through the also-iconic Palm Court, famous for its classic high tea (you should definitely check it out 🫖). But this is about another New York icon, so I rushed through to get to my seat which was stage right of the podium. The lunch service was elegant, but I didn’t eat a morsel because I was so excited in anticipation of seeing Yellen up close.
After a brief introduction, Yellen graciously accepted her award, climbed up onto her famous step stool and settled in behind the podium. She dove into her comments—some 3,278 words worth of pure Janet Yellen. She did not talk of her time at the Fed. She did not criticize our current Fed, nor did she slip into the all-too-familiar-these-days finger pointing politics we have become used to from political appointees. No, she talked about her time spent as Treasury Secretary over the past 4 years.
It was a tumultuous 4 years for the US Economy as she entered the Treasury Department on the heels of the pandemic, when the unemployment rate was still above 6% and the economy was still reeling from the flash recession of 2020. Supply chains were in a state of chaos. I am sure that you remember how impossible it was to get your hands on just about anything—cars, dishwashers, TVs, Webcams… CHICKEN NUGGETS for your grandchildren—it was a mess. Then there was Russia’s invasion of Ukraine which caused energy prices to spike. Then came inflation at levels not experienced by Americans since the 1980s, followed by a massive Fed tightening campaign.
So here we are. The economy is chugging along in remarkable health. Unemployment is low and inflation… well, inflation is not quite licked yet and it is still very present in the capital markets and your budget. Back to the speech. My regular followers know that I cover this stuff really closely, so much of Yellen’s speech was straight-forward, standard fare for a Treasury or Fed official. I will give you a link to the transcript later, but I want to highlight something that caught my attention.
We know that the latest spate of high inflation was sparked by pandemic-era, supply chain gum-up, which led to supply-push inflation. The flames of inflation were then fanned by the massive fiscal stimulus which caused demand-pull inflation. We, together, have covered this quite a bit over the past few years. In her speech yesterday, Yellen provided something I rarely hear in these types of speeches. She offered what she termed as a “counterfactual” consideration: “how inflation and labor market outcomes would have differed under alternative policy choices.” In other words, rather than focusing on minimizing unemployment by providing massive fiscal stimulus, what if the Biden Administration along with the Fed focused solely on keeping inflation in check at the Fed’s 2% target. She got my attention… um, double attention.
I have written quite a bit about the Phillips curve which shows the relationship between inflation and unemployment. Yellen asked, “..how much more unemployment would have resulted from a fiscal contraction sufficient to keep inflation at the Fed’s 2 percent target?” Got it? So, if there is high unemployment, there are less dollars chasing goods along with low consumer sentiment. Less demand for goods keeps inflation in check. It is the classic tradeoff between the dual mandate of the Fed.
Please stay with me, I am almost there. Yellen posited that the Phillips Curve may be quite flat. That means that the relationship between unemployment and inflation is weak. It exists, but the flat slope suggests that low unemployment does not have a strong impact on inflation. BUT, in her counterfactual, the implication is: you would have to have very high unemployment in order to keep inflation at the Fed’s target. In fact, she said that unemployment would have to have risen as high as 14% in order to keep inflation at 2%! That would be an additional 9 to 15 million Americans out of work. Now, maybe it’s because I am a nerd, para-academic, and a fanboy of Janet Yellen, but I found her analysis to be profound. A counterfactual! It gave me a glimpse into what a discussion with her FOMC, The President, or her also-brilliant husband might be like. I found it interesting that she used that weighty argument to justify the massive Biden-era fiscal stimulus. In other words, it wasn’t demand-pull but rather supply-push which caused the epic rise of inflation in 2021 and 2022.
Now, I am not agreeing or disagreeing with her, but I do want you to continue to ponder the Phillips curve. I didn’t have time to run the regression myself this morning, but I did find a Fed paper on the Phillips curve, published last fall. The gist of the paper was that the curve was nonlinear. That is a cool topic which I want to explore more in the future, but the study did manage to crunch out a more contemporary view of the Phillips Curve, which I inserted below. Now, I am going to make my academic friends cringe with this, but if you look at the scatter plot and try to fit a line through it (linear or curvilinear), you can see that the slope of the line (or a tangent to the curve, if you agree that it is nonlinear), is indeed quite FLAT.
Touche and cheers Ms. Yellen!! It was an honor to be in the presence of Secretary Yellen. I am sure that this will not be her final word on the US Economy, and I look forward to whatever may be next for Janet Yellen.
You can read all of Janet Yellen’s comments here: https://home.treasury.gov/news/press-releases/jy2786
YESTERDAY’S MARKETS
Stocks lurched higher yesterday in response to a strong start of earnings season and a softer-than-expected inflation figure. While CPI is still heading in the wrong direction, investors cheered the undershooting of the core figure which excludes Food and Energy. After a rough start of the year, stock investors were desperately seeking a catalyst to shift to the forward foot and yesterday’s CPI print became that spark. The first few companies out of the chute for Q4 earnings season set a positive tone for many that will follow in the weeks to come.
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