Yellen Can't Change Fed Policy

First the good news: Yellen is a monetarist, a dove and an activist. She believes that monetary policy plays an important role in achieving good economic growth, and that the Fed should respect its employment mandate . She is more dovish than Bernanke, and more forceful. She is, in my view, an improvement over Bernanke who placed too much emphasis on consensus.

Now for the bad news: Like Bernanke, Yellen will be faced with the hawkish faction which is likely to tie her hands and prevent her from doing what she believes is right. Were Yellen to advocate more radical policies, such as price-level targeting or nominal growth targeting, she would invite discord and vocal dissent. She would injure the Fed’s “institutional credibility”, and invite Congressional interference, which is anathema.

So here is the bottom line: Yellen will fail as Bernanke has failed. Only radical policies can move the dial on money growth, and radical policies are precluded by the hawks. Indeed, the hawks want to return to orthodoxy as soon as possible. She will have her hands full fighting against this tendency.

Thus, the outlook for the US economy is grim: low money growth, low inflation, low growth, high unemployment, weak fiscal revenue and an ever-growing output gap. That suggests that the bond market should not react to her appointment: she can’t raise the inflation rate any more than Bernanke could.