Share Your Thoughts

For some people 1929 was just another year in history, others recognize it as the beginning of the Great Depression.

Many economic control mechanisms like the Securities and Exchange Commission (SEC) and securities law were enacted to avoid having another Great Depression. Yet, despite all our sophistication and professed understanding of markets, in 2007 the United States was hit with the Credit Crisis.

Now, in 2014, we look back at the last eight years of monetary policy and are grateful that Ben Bernanke was able to draw on his knowledge of 1929-1933 to bring America out of one of the worst economic crises of all time. Now with Bernanke retiring, he has passed the torch onto Janet Yellen who will face an equally challenging tenure as the Chair of the Federal Reserve.

The Hawk and the Dove

Prior to her time as the Vice President of the Federal Reserve, Janet Yellen was the President of the Federal Reserve Bank of California from 2004 to 2010. Before the financial crisis hit in 2007, Yellen became well known in finance circles as an outspoken critic of increasing house prices calling it a bubble. Although vocal in her opinions, she did not take action against easy lending policies and instead looked to Washington for change, which never came. In 2010, Janet Yellen succeeded Donald Kohn as Vice President of the Federal Reserve.

During her time as the Vice President, she often aligned with the opinion of Benjamin Bernanke when discussing monetary policy decisions. She, like Bernanke, is described as a “dove” when it comes to policy leaning towards cautious rather than aggressive.

As we were coming out of the recession in 2013 growth was sluggish, economic outlook was mixed, and the post of Federal Reserve chair was open with the retirement of Bernanke imminent. On one end was Janet Yellen—dovish, unassuming, cautious and chaired President Clinton’s Council of Economic Advisers. On the other end was Larry Summers—hawkish, aggressive and polarizing, the former Secretary of the Treasury and economic advisor to two presidents.

Although initial support rallied around Larry Summers, the opinion that the market needs cautious and gentle guidance versus a more risky, shorter tapering period and potential volatility which Summers preferred- became the guiding factor which led Yellen to be tapped for the position.

Monetary Policy—An Inflated Issue

We all know that the Federal Reserve has a severely inflated balance sheet due to an expansionary monetary policy for the last 6 years. Monetary policy, at the start of the recession, consisted mainly of short term bond purchases to drive down short term interest rates but transitioned to a blend of short and long term bonds in response to the severity of the financial crisis.

Until December 2013 the Federal Reserve was making asset purchases of $85B per month. There was a lot of debate among experts, about when the tapering (reducing the amount of the bond buying) would begin.

The Federal Reserve had previously stated that they would use a 6.5% target unemployment rate and multiple quarters of strong economic growth before even considering the possibility of tapering. By definition, the unemployment rate measures the number of people without jobs in the total labor force, which is the number of people actively seeking jobs. As people gave up on looking for a job, the labor force pool shrank —leading to a reduction in the unemployment rate, making it a less reliable indicator of the health of the economy.


In December 2013, the Federal Reserve made its first taper ever, from $85B to $75B and then again in January to $65B per month. Although tapering has begun, it is not yet a cause for celebration. A $4.1 trillion cash position is not an easy one to unwind. One cannot just go from pumping $85B per month into the economy to nothing; it would cause chaos.

Furthermore, tapering in and of itself is not the issue—it is what follows that the Fed must be careful with. The implication of tapering is that at some point in the future Yellen must make a decision on interest rates.

During the recession there was a flight to safety, money poured into fixed income investments. Fund managers and analysts with exposure to fixed income flourished when interest rates dropped to the near zero levels, which led to increased bonds values.

Now that circumstances are less dire, these same individuals have been looking to Fed policy to predict when tapering would occur so that they could safely exit their positions. This is the reason why Bernanke held monthly meetings and quarterly public interviews: the more the public is aware about future policy decisions, the less volatile capital flows, and by extension, our stock market will be.

With the economy growing at an annualized 3.2% in Q413 it became clear that we are finally on the road to recovery. Many believed that the tapering was coming much sooner than initial late 2014 estimates, so they started slowly unwinding their fixed income positions and will continue to do so in a controlled way.

On the World Stage

The last few years have been very difficult for the economy. Janet Yellen, like her predecessor, has inherited the Federal Reserve at a challenging time. Even a simple economic behavior like a dropping unemployment rate has become a more contentious debate because of its cause. A 6.5% unemployment rate was once considered a true measure of a recovering economy, now the Fed has said it will be re-evaluating its use in monetary policy.

Janet Yellen’s actions also have an impact on the world stage. While times were tough in the United States, capital was flowing to other countries with more attractive interest rates like Argentina, Turkey, and India. Now these countries with poor trade deficits are experiencing capital outflows exposing their weaknesses, which was masked in the past by the capital inflows.

The country has been through major surgery, Janet Yellen needs to be very careful in how quickly she takes the patient off painkillers.

Rahul Varshneya graduated from the Leavey School of Business at Santa Clara University with a degree in finance and is working in the technology industry as a financial analyst.