Yellen's main challenge at the Fed: Communicate

(MoneyWatch) If Janet Yellen wasn't the White House's first choice to lead the Federal Reserve, she is expected to get a warmer reception from Wall Street.

If confirmed by the Senate, Yellen would become the first woman to lead the central bank since the Federal Reserve system was created in 1913. But for investors, financial firms and other market participants, her gender is less important than her views on monetary policy, communication style and plans for helping nurse the economy back to health. 

"The main challenge for Yellen is that the last challenge hasn't ended," said Tim Duy, an economist with the University of Oregon and a noted Fed watcher. "We still haven't emerged from the financial crisis."

Indeed, Yellen would replace current Fed Chairman Ben Bernanke, whose term ends Jan. 31, 2014, at a delicate moment for the economy. Although many economists forecast stronger growth next year, the pace of expansion and job-creation in 2013 has been disappointing.

Yellen, who is currently the Vice Chair of the Fed, has had a long tenure at the central bank. She started at the Fed as an economist in 1977. Following stints in academia at the University of California, Berkeley, and London School of Economics, she joined the bank's Board of Governors in 1994. From 1997 to 1999, Yellen served as President William Clinton's chief economic adviser, returning to the bank from 2004 to 2010 as president of the Federal Reserve Bank of San Francisco.

In her monetary philosophy, Yellen, 67, is seen as closely aligned with Bernanke, who has used a series of extraordinary measures during his tenure to bolster the economy. That harmony is likely to play well with investors, who may find it easier to predict monetary policy than if her views clashed with those of her predecessor.

"Overall, Yellen's nomination doesn't change our view that interest rates will remain at rock bottom for at least another 18 months and rise only gradually after that," market research firm Capital Economics said in a note to clients.

The Dow Jones industrial average gained 26 points to close at 14,803, reversing two straight days of losses that analysts linked to the ongoing partial government shutdown and congressional standoff over the debt ceiling. Activity on the Standard & Poor's 500 and Nasdaq composite index was largely flat.

Like Bernanke, Yellen is often labeled a "dove," the term of art for Fed members who typically favor policies aimed at ensuring full employment (By contrast, "hawks" focus on maintaining price stability.) But that view is simplistic, experts said, pointing to her history of combating inflation at the Fed.

"One key is that Dr. Yellen was a staff economist at the Federal Reserve Board in the late 1970s, during a period of high and accelerating inflation. So she's very aware of what can happen if monetary policy becomes too lax," said Gus Faucher, senior economist with PNC Financial Services Group. "She recognizes that the Federal Reserve has a dual mandate of maximum employment and price stability, and she takes both parts of that mandate seriously."

Boston College economist Peter Ireland also credited Yellen with having been one of the only policy makers at the Fed who warned about growing financial stability in the years leading up the housing crash.

One area certain to draw scrutiny is how Yellen's leadership and communication style might differ from Bernanke's approach. Bernanke has given Fed members wide latitude to speak their minds. Although such collegiality has arguably helped transparency by exposing investors to the full range of Fed opinions on economic matters, it has also confused investors by blurring the central bank's policy messages.

An important question is whether Yellen would emulate Bernanke's consensus-driven style or if she would seek to unify the pronouncements by members of the Federal Open Market Committee, the panel that meets eight times a year to set interest rates and discuss other policy matters.

Adding to the challenge for Yellen is that she would be taking the helm at a time of broader transition for the FOMC, whose members rotate on an annual basis. More dovish members of the panel, such as Chicago Fed Bank president Charles Evans and Eric Rosengren of the Fed Bank of Boston, will be replaced as voting members by more hawkish Fed bank leaders. That could complicate efforts to unify policy and keep FOMC members in tune.

One of Yellen's first tests as Fed chair would likely be to offer clearer guidance on policy, especially the bank's plans for winding down its $85-billion-a-month program to buy Treasury and mortgage bonds. The purchases, which the Fed started in 2008 to prop up the economy as it was shrinking under the impact of the housing crash, are widely believed to have boosted stocks. But some Fed officials have increasingly pushed to end the program because of concerns it could prompt inflation.

Notes from the FOMC's Sept. 17-18 meetings highlight the difficulty Yellen could face on that score. The minutes, released today, show that the committee was divided in its assessment of the job market and on the timing for withdrawing stimulus.

Before she can be confirmed as Fed chair, Yellen must first be recommended by the Senate Banking Committee. Several Democratic members of the panel effectively blocked the nomination of former U.S. Treasury Secretary Lawrence Summers, who was said to be President Barack Obama's preferred nominee to lead the Fed. Summers withdrew as a possible candidate last month after it became clear that he lacked the votes on the committee.

Ordinarily, Yellen could be expected to have an easier ride, having already been vetted by the committee on being nominated as Vice Chair in 2010. But the government shutdown and partisan dispute over raising the government's borrowing limit could affect the reception Yellen gets from Senate Republicans. 

Some Republicans were already on the attack Wednesday even before Mr. Obama had formally nominated her.

"Ms. Yellen subscribes to the liberal school of thought that the best way to handle to our nation's fiscal challenges is to throw more money at them," said Sen. John Cornyn, R-Texas, in a statement. "This stimulus obsession is the reason the nation finds itself in the fiscal calamity it does today, and the last thing we need is a leader at the helm of the Federal Reserve who is intent on more quantitative easing that harms our economy and further burdens hard-working Americans."

Hardliners in the chamber also could zero in on her lack of private-sector experience and seek to draw her out on the issue of financial regulation, which many conservatives in Congress oppose and where Yellen's views are largely unknown.

"If Obama bloodies the GOP's noses on the budget, they could bloody him right back by holding up the choice for Fed chair," Duy said.