Janet Yellen: Navigating Uncharted Waters

Abstract

In January 2016, Janet Yellen, finishing her second year as chair of the Board of Governors of the U.S. Federal Reserve, was navigating uncharted waters along a number of dimensions. She had inherited an unruly FOMC. Over the past year, some members had publicly called for more expansionary Fed policy; others called for an end to the expansionary Fed policy; and still others worried aloud that Fed policy might be creating bubbles and risks to financial stability. And Yellen faced at least three pressing questions: How, after the Fed's balance sheet had expanded fourfold in a few short years, should the Fed guide the public through the eventual unwinding of that balance sheet? Relatedly, when should it begin to sell some of its $2.46 trillion in Treasury holdings? And was the December 2015 increase of the federal funds rate—the start of the first tightening phase in more than a decade—the right decision, or would the U.S. economy falter and force the Fed to reverse course? This case also presents a brief history of Fed policy and asks the reader to consider the best course of action for the Fed to take. This case was written as an updated version of “Yellen, Guidance, and the Exit Strategy,” (GEM-0121) and may be used in its place. Excerpt UVA-GEM-0134 Rev. Mar. 6, 2017 Janet Yellen: Navigating Uncharted Waters [N]o central bank anywhere on the planet…has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank—not, at least, the Federal Reserve—has ever been on this cruise before. —Richard W. Fisher, President and CEO, Federal Reserve Bank of Dallas In February 2017, Janet Yellen, entering her fourth and likely final year as chair of the Board of Governors of the U.S.Federal Reserve (the Fed), looked out at the Lincoln Memorial while reflecting on the Federal Open Market Committee's tentative tightening of U.S. monetary policy. For Yellen, the modest year-end tightenings in 2015 and 2016 were first steps toward a normalization of U.S. monetary policy. She knew that short rates had been too low for too long—the federal funds rate had been near 0% for seven years—perhaps sowing the seeds for future financial crises, and that some upward movement in the federal funds rate would, all else equal, be desirable. She also yearned for the day when the Fed, rather than being the single largest holder of U.S. Treasury bonds, would once again have a boring, inconsequential Treasury portfolio. . . .