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# Copyright

## Copyright

Yellen and The Fed: A WSJ Briefing  
The Wall Street Journal  
Copyright 2014 Dow Jones & Company, Inc.  
Smashwords Edition 

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# Introduction

##  Introduction

_For Fed Chairwoman Yellen, the Top Job at a Crucial Time_

_By Jon Hilsenrath_

When President Barack Obama called on Janet Yellen to become the next leader of the Federal Reserve, he placed in the hands of the five-foot-tall, gray-haired economist from Brooklyn one of the most consequential challenges of our time.

She must decide when the recovering U.S. economy is ready to stand on its own without the unconventional cocktail of financial medicine the nation's central bank has administered to it during the past six years of market turmoil, recession and sluggish recovery.

The Fed has pushed short-term interest rates near zero and promised to keep them there until the economy is on a stronger footing. It has also pumped money into the financial system, accumulating a bond portfolio that, at more than $4 trillion, is nearly as large as the combined assets of JPMorgan Chase & Co. and Bank of America Corp., the nation's largest commercial banks. Those moves came after bailouts and other rescue programs launched during the 2008 financial crisis to prevent the financial system from collapsing.

The central bank's interest rate policies are meant to lighten the burden of heavy debts assumed during the housing boom of the 2000s and encourage new borrowing. The Fed hopes low rates will prompt households and businesses to keep spending and investing while the economy heals from the worst financial crisis since the Great Depression.

Eventually, Fed officials expect, the economy will be strong enough to create new jobs and rising incomes without ultra-cheap credit. But when that moment of normalcy will come is uncertain and government officials have fumbled that prediction in the past, with grave consequences.

During the Great Depression, the Fed tightened credit when the economy was still vulnerable, such as in 1931 and 1937, prolonging the human misery resulting from the deep downturn. In the 1970s, the Fed kept credit cheap for too long and inflation ensued. And in the 2000s, the Fed kept rates low after another recession, potentially contributing to the housing bubble that emerged.

Ms. Yellen's first decision comes March 19, when the Fed completes its first policy meeting under her leadership. Front and center will be the bond-buying program the Fed started pulling back in December 2013, a process Ms. Yellen has signaled will continue. Next, she must decide when to start raising interest rates, a process she wants to defer as long as inflation is low and no new financial bubbles emerge.

"While we have made progress, we have farther to go," said Ms. Yellen, standing beside Mr. Obama in October 2013, when he announced he was nominating her to the top Fed post. "The mandate of the Federal Reserve is to serve all the American people, and too many Americans still can't find a job and worry how they will pay their bills and provide for their families.

"The Federal Reserve can help, if it does its job effectively," Ms. Yellen said. "We can help ensure that everyone has the opportunity to work hard and build a better life. We can ensure that inflation remains in check and doesn't undermine the benefits of a growing economy. We can and must safeguard the financial system."

Who is Janet Yellen? What experiences formed her? Can the nation trust her judgment?

The stories in this briefing --selected from decades of Wall Street Journal reporting about the economy, the central bank and national policy makers -- form an in-depth portrait of the woman with the levers of the global financial system at her fingertips.

Ms. Yellen, 67, was raised in a three-story brownstone apartment in Brooklyn in the 1950s, one of two children. Her father, the neighborhood doctor, worked in the basement and made house calls. Her mother translated books into Braille as charitable work and tracked the family stock portfolio in small, neat handwriting. Young Janet Yellen was a perfectionist who collected rocks, a high-school class valedictorian and editor of her school newspaper who once kiddingly interviewed herself in print.

"The world we grew up in was a very secure world," her brother, John Yellen, told The Wall Street Journal in an interview in 2013.

Her mother's meticulous, do-gooder spirit is often reflected in Ms. Yellen today. The chairwoman is known inside the Fed for arriving at policy meetings with carefully researched statements about the economy and for pressing central bank economists on the nuances of their work. "These are not just statistics to me," she said in a February 2013 speech to the AFL-CIO labor union. "We know that long-term unemployment is devastating to workers and their families."

James Tobin, the late Nobel prize-winner and Yale University professor, became the dominant figure in her education, shaping her worldviews about government and economics. Mr. Tobin, her dissertation adviser at Yale, was an intellectual heir to the Depression-era economist John Maynard Keynes, who saw a central role for government in combatting economic downturns.

Mr. Tobin was at odds with free market economists at the University of Chicago, and academic battles raged over the role of government in the economy during the 1960s and 1970 as Ms. Yellen's own views were forming. She came down clearly on Mr. Tobin's interventionist side.

"The Yale macroeconomic paradigm provides clear answers to key questions dividing macroeconomists," Ms. Yellen said at a Yale reunion in 1999.

Critics worry she is too liberal and so concerned about unemployment that she might fail to keep inflation contained.

Complicated economic questions confront the Fed today, creating divisions and uncertainties among policymakers.

Inflation hasn't performed in the past few years as many economic models suggested it would. The supply and demand effects of high unemployment and millions of empty homes suggested to some economists that inflation would fall sharply or consumer prices might even plunge. Other economic models suggested the Fed's aggressive money-printing efforts might push prices sharply higher.

Instead, inflation has been relatively steady in recent years. Economic growth, meanwhile, has failed to revive as the Fed's economics models projected it would. And the Fed is trying to develop new strategies, unimagined even a decade ago, for confronting the threat of financial bubbles.

Few economists are better prepared for the job than Ms. Yellen. She was a Fed staff economist in 1977 and 1978, when she met her husband George Akerlof, an economist and frequent co-author who went on to win a Nobel Prize. She served in the mid-1990s as a Fed board governor in Washington, in the 2000s as president of the Federal Reserve Bank of San Francisco, and most recently as Fed vice chairwoman.

She did stints as a professor--at the University of California at Berkeley--and as chair of President Bill Clinton's Council of Economic Advisers.

She overcame obstacles along the way, including a challenge by White House favorite Lawrence Summers to succeed then-Fed Chairman Ben Bernanke.

Ms. Yellen has made a habit of arguing her cases forcefully. Her record reveals a low-key battler who has confronted some of the nation's most powerful decision-makers. In a 1996 debate about whether the Fed should establish a specific target for inflation, Ms. Yellen pressed then-Fed Chairman Alan Greenspan to clearly state his view, the kind of challenge he rarely faced at the time.

"She's tough--not just because she's from Brooklyn," Mr. Obama said of her in October.

At the tail end of the housing boom that preceded the last crisis, she warned other officials about risks she saw looming over the economy.

"I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector," she said in a June 2007 policy meeting, according to official Fed transcripts. "The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst."

That judgment proved right, and so have others. A Wall Street Journal analysis of more than 700 predictions that Fed officials made between 2009 and 2012 showed Ms. Yellen had the most prescient record of public statements in the period after the financial crisis ended, warning others that the recovery would be slow and playing down the threat of inflation.

But her record isn't perfect. She admitted to a government commission in 2010 that as president of the San Francisco Fed in the 2000s, she was sometimes hesitant to push her examiners to crack down harder on reckless bank lending practices because she felt she lacked the authority. At Fed policy meetings, she spoke her mind but never dissented from an official policy decision.

Now she will be driving those decisions and defining the boundaries of the Fed's authority.

Ms. Yellen, in her first testimony to Congress in 2014, signaled she wants to carry forward with her predecessor's plans to gradually wind down the Fed's bond-buying program and avoid interest rate increases in the near term. The Fed forecasts that by late 2016 the economy will be growing steadily, unemployment will be well below 6% and inflation will be steady near 2%.

It was nearly two years into Mr. Bernanke's term that officials realized the Fed's forecasts were wrong and the economy was going off the rails. One of Ms. Yellen's primary tasks will be ensuring the Fed doesn't steer so far off the mark again.

Jon Hilsenrath is The Wall Street Journal's Chief Economics Correspondent.

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# Contents

##  Contents

**THE BACKDROP: A TURNING POINT FOR THE FEDERAL RESERVE**

**Yellen Gets Fed Nomination With Bank at Turning Point**

_Janet Yellen, if confirmed to lead the Federal Reserve, faces the difficult task of defining when the central bank will step back from the expansive monetary programs employed over the past six years to salve the crisis-racked economy. By Jon Hilsenrath (Oct. 9, 2013)_

**Fed Dials Back Bond Buying, Keeps a Wary Eye on Growth**

_Ben Bernanke gave the U.S. economy a nod of approval just a month before he leaves the Federal Reserve, moving the central bank to begin winding down a bond-buying program meant to boost growth with the recovery on firmer footing. By Jon Hilsenrath and Victoria McGrane (Dec. 18, 2013)_

**Rate Decision to Drive Yellen 's Early Agenda**

_In three years as second-in-command at the Federal Reserve, Janet Yellen worried continuously about high U.S. unemployment and pushed for policies to bring it down. After she is sworn in as Fed chairwoman Monday a new question will almost immediately crowd her agenda: Why is unemployment falling so fast and what, if anything, should the central bank do about it? By Jon Hilsenrath and Victoria McGrane (Feb. 2, 2014)_

**THE PERSON: TRACING JANET YELLEN 'S RISE**

**Jobless Puzzle: Why Unemployment Sometimes Lingers On Stirs Renewed Interest**

_When George Akerlof was 11 years old, he worried about this: If his father lost his job, he would stop spending, causing someone else to lose a job, who would also stop spending, and so on until the economy crashed to a halt. Fortunately, young George 's theory was flawed. His father periodically did lose his job, but the economy survived. That early intellectual misfire didn't discourage Mr. Akerlof, now an economist at the University of California at Berkeley, from continuing to think about unemployment. He and his wife, Janet Yellen, are members of a small band of maverick economists exploring new theories of joblessness. By Alan Murray (Dec. 25, 1985)_

**Clinton Selects Two Economists For Posts at Fed**

_President Clinton picked two economists with distinguished academic pedigrees for the Federal Reserve Board, hoping they can persuade the Fed to increase its emphasis on growth. By David Wessel (April 25, 1994)_

**Back to the World: Berkeley 's Economists Attack Policy Issues With Unusual Gusto**

_Activists have taken over at Berkeley, again. The school that was synonymous with 1960s tie-dyed radicalism is once more in the vanguard. This time it 's shaking up the economics profession, and the rebels are on the faculty, the 42 Ph.D.s in the Department of Economics at this University of California campus. By Thomas T. Vogel Jr. (Nov. 30, 1995)_

**Janet Yellen, a Top Contender at the Fed, Faces Test Over Easy Money**

_The next chief of the Federal Reserve will decide when to reverse the easy-money policies of Ben Bernanke, a judgment that could strangle the economic recovery if made too early or trigger runaway inflation if made too late. By Jon Hilsenrath (May 12, 2013)_

**THE BATTLES: FIGHTS ABOUT POLICY, MANAGEMENT AS YELLEN ROSE**

**Senators Confirm Yellen for Fed**

_Janet Yellen will join the ranks of the most powerful economic policy makers in the world next month, taking the helm of the Federal Reserve at a time when the central bank is assessing its unprecedented steps to buoy the U.S. economy. By Kristina Peterson and Pedro Nicolaci da Costa (Jan. 7, 2014)_

**Yellen Would Bring Tougher Tone to Fed**

_Janet Yellen, the lead candidate to succeed Federal Reserve Chairman Ben Bernanke, brings a demanding and harder-driving leadership style to the central bank, in contrast to Mr. Bernanke 's low-key and often understated approach. By Jon Hilsenrath (Sept. 22, 2013)_

**Inflation Fears Cut Two Ways at the Fed**

_The Federal Reserve 's decisions to keep interest rates near zero and to flood the financial system with credit are sparking fears of an eventual outbreak of inflation. But inside the Fed, an influential band of policy makers is fretting over the opposite: that the already-low rate of inflation is slowing further. By Jon Hilsenrath (April 3, 2010)_

**Fed Chief Choice Shapes Up as Race Between Summers, Yellen**

_The race to become the next leader of the Federal Reserve looks increasingly like a contest between two economists: Lawrence Summers and Janet Yellen. By Jon Hilsenrath (July 25, 2013)_

**Summers Withdraws Name for Fed Chairmanship**

_Lawrence Summers pulled out of the contest to succeed Ben Bernanke as chairman of the Federal Reserve after weeks of public excoriation, forcing President Barack Obama to move further down the list of contenders to head the central bank. By David Wessel (Sept. 16, 2013)_

**THE RECORD: A GOOD, NOT SPOTLESS, RECORD ON THE ECONOMY**

**Federal Reserve 'Doves' Beat 'Hawks' in Economic Prognosticating**

_As the U.S. emerged from recession in the summer of 2009, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, took a grim view of the economy 's prospects. By Jon Hilsenrath and Kristina Peterson (July 29, 2013)_

**Fed 's Yellen Says Stance on Banks Hardened**

_Janet Yellen, a top contender to lead the Federal Reserve, has evolved --in her own words--from a slightly "docile" regional bank regulator into a proponent of hard and clear rules designed to make banks less risky. By Damian Paletta (August 12, 2013)_

**Records Show Fed Wavering in 2007**

_Federal Reserve officials in 2007 appeared to underestimate the sickly condition of U.S. financial markets before shifting to a state of growing alarm, according to 1,566 pages of newly released transcripts from the central bank 's meetings that year. By Jon Hilsenrath and Kristina Peterson (Jan. 18, 2013)_

**THE POSITIONS: YELLEN PLANS TO CARRY ON BERNANKE 'S APPROACH**

**Yellen Stands by Fed Strategy**

_Janet Yellen, the White House 's nominee to run the Federal Reserve, suggested she would stick to plans to wind down the central bank's $85 billion-a-month bond-buying program in the coming months if the economy perks up. By Jon Hilsenrath and Victoria McGrane (Nov. 14, 2013)_

**Fed 's Yellen Sets Course for Steady Bond-Buy Cuts**

_The Federal Reserve will keep winding down one of its highest-profile easy-money programs unless the economy takes a serious turn for the worse, Janet Yellen said in her inaugural public appearance since becoming the central bank 's first chairwoman. By Jon Hilsenrath and Victoria McGrane (Feb. 11, 2014)_

**Yellen Is Obama 's Choice as Fed Chief**

_President Barack Obama will nominate Janet Yellen to run the Federal Reserve, calling on the central bank 's second in command to become the world's most powerful economic policy maker after months of sometimes bitter debate about Chairman Ben Bernanke's successor. By Jon Hilsenrath and Peter Nicholas (Oct. 9. 2013)_

**THE ECONOMY: FED CONFRONTING DOUBTS ON GROWTH, BUBBLES, INFLATION**

**Slack Attack: Fed Faces Test on Inflation**

_Tens of thousands of people who moved to Bend in the past decade saw a booming real-estate market and plentiful jobs amid the mountains of Central Oregon. Now they see slack. Slack --the unused portion of an economy's productive capacity--is evident across the U.S. By Sara Murray and Jon Hilsenrath (Sept. 20, 2009)_

**Markets Defy Fed 's Bond-Buying Push**

_The Federal Reserve 's decision to spur the economy with a $600 billion round of bond buying was among the most controversial in its history. By Jon Hilsenrath and Mark Whitehouse (Dec. 8, 2010)_

**Fed Debates New Role: Bubble Fighter**

_Not so long ago, Federal Reserve officials were confident they knew what to do when they saw bubbles building in prices of stocks, houses or other assets: Nothing. Now, as Fed Chairman Ben Bernanke faces a confirmation hearing Thursday on a second four-year term, he and others at the central bank are rethinking the hands-off approach they 've followed over the past decade. By Jon Hilsenrath (Dec. 1, 2009)_

**About This Book**

_Credits, Contact Information and Links_

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# THE BACKDROP: A TURNING POINT FOR THE FEDERAL RESERVE

# The Backdrop: A Turning Point for the Federal Reserve

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# Yellen Gets Fed Nomination With Bank at Turning Point

##  Yellen Gets Fed Nomination With Bank at Turning Point

_By Jon Hilsenrath_

_Oct. 9, 2013_

Janet Yellen, if confirmed to lead the Federal Reserve, faces the difficult task of defining when the central bank will step back from the expansive monetary programs employed over the past six years to salve the crisis-racked economy.

President Barack Obama introduced Ms. Yellen, beaming at his side, as his choice to become chairwoman of the central bank when Ben Bernanke's term ends in January. Her nomination is subject to Senate confirmation.

"A lot of people aren't necessarily sure what the Federal Reserve does," Mr. Obama said. But thanks to the Fed under Mr. Bernanke, he added, "more families are able to afford their own home, more small businesses are able to get loans to expand and hire workers, more folks can pay their mortgages and their car loans."

The selection of the 67-year-old Ms. Yellen was historic on many levels. In one stroke, Ms. Yellen has a chance to become the first woman to run the Fed since its founding in 1913, the most powerful economic policy maker on the globe and one of the most influential women in U.S. history.

It also puts her in a position to place her stamp on one of the most inscrutable but influential institutions in the U.S. government. The Fed was established after a financial crisis in the early 20th century to provide emergency lending to banks during economic panics. Its role and powers have grown since, to regulating banks, stabilizing inflation and softening the blows of a volatile economy on the nation's workforce. According to a law passed in 1977, the Fed is assigned to achieve what is known as a "dual mandate" of maximum employment and stable prices.

Tested by the 2008 financial crisis, Mr. Bernanke pushed the Fed's boundaries in his efforts to stabilize an ailing economy. But the wisdom and effectiveness of his signature programs remain subjects of intense debate inside the Fed, on Wall Street trading floors, in the boardrooms of foreign central banks and in the halls of Congress. Most hotly debated is a bond-buying program often called quantitative easing, or QE, which has vastly expanded the Fed's holdings of securities.

Ms. Yellen now gets to put her own postscript on programs she helped to write. Her big decisions in the next four years will involve deciding when to pull back from these efforts.

In brief comments after Mr. Obama introduced her, she suggested that she is in no hurry to pull back now. "More needs to be done to strengthen the recovery," she said in a statement. "Too many Americans still can't find a job and worry how they'll pay their bills and provide for their family."

Whether the Fed can do much to help them is a central point of contention that she will need to manage with 18 other policy makers who take part in the Fed's decisions.

The Fed has a simple but extraordinarily powerful tool that it uses to guide the economy: It can print money and use that money to accumulate securities. Dollar bills have the Fed's name emblazoned across their top, and in the modern digital age the Fed can deposit billions in the blink of an eye into the accounts of banks, which then filter into the economy.

In normal times the Fed uses this power to manage the money supply to guide very short-term interest rates--rates that banks charge each other on overnight loans--and then lets the private sector do the rest of the work in driving credit to or away from businesses and households. Lowering the rate tends to encourage borrowing, which spurs near-term spending and investment; raising the rate tends to do the opposite. If it prints too much money, it can cheapen a dollar's value and cause inflation.

During the financial crisis, the Fed pushed short-term rates to near zero in an effort to encourage economic activity even as businesses, banks and households pulled back. With Ms. Yellen's strong support, the Fed has promised to keep rates low until the unemployment rate, now 7.3%, gets below 6.5%. The Fed went a step further, using its money-printing ability to buy trillions of dollars' worth of long-term Treasury and mortgage securities in an effort to push longer-term rates even lower.

Since 2006, the Fed's securities holdings have expanded from $750 billion to $3.5 trillion. Much of that increase has happened since the financial crisis ended in 2009, but some question whether it was worth the risk given the mixed results in the economy. The economy has been stuck at a meager growth rate around 2% through four years of recovery, though unemployment has fallen notably from 10% at its worst. Inflation, meantime, is running below the Fed's 2% goal, which Ms. Yellen had a role in establishing. Though the Fed has printed a great deal of money, risk-averse banks aren't lending much of it and debt-constrained consumers aren't borrowing much.

The first challenge on Ms. Yellen's agenda, if confirmed, will be steering debate within the Fed about whether to start pulling back the $85 billion-a-month bond-buying program that many officials want to wind down as the unemployment rate falls.

Fed officials decided at their September meeting against trimming the bond purchases. For many of the officials, that was a "relatively close call," according to minutes of the meeting released Wednesday.

Later, she will need to lead discussions about when to begin raising short-term interest rates.

Ms. Yellen suggested Wednesday that she brings to the job an expansive view of the Fed's responsibilities.

"We can help ensure that everyone has the opportunity to work hard and build a better life," she said Wednesday at the White House. "We can ensure that inflation remains in check and doesn't undermine the benefits of a growing economy. We can and must safeguard the financial system."

But some officials and private economists think the Fed needs to take a narrower view of what it can achieve with easy-money policies.

In a statement about their goals that Ms. Yellen helped to craft in 2012, Fed officials agreed that in the long run their policies dictate the level of inflation. Most agree they can shape growth and unemployment in the short run by nudging people's borrowing plans, but the Fed said in this statement that other factors determine the economy's long-run growth rate and job gains. These factors include influences such as productivity, population growth or regulatory policies.

"The limits of monetary policy are pretty clear," said Marvin Goodfriend, a professor at Carnegie Mellon University's Tepper School of Business. "Monetary policy essentially over the medium- to longer-term only affects inflation."

The Fed's own research suggests the bond-buying program has had modest benefits. But Ms. Yellen has argued the costs of running these programs are small. Inflation hasn't taken off, as many critics of the programs predicted would happen. The dollar has been steady compared with other currencies even as the Fed has printed trillions more, despite warnings its value would collapse. However, some officials became worried earlier this year that the Fed might be stirring new financial bubbles.

"There is just a limit to what the Fed can do," said Martin Feldstein, a Harvard University professor who has known Ms. Yellen since they were co-teachers in a class on macroeconomics at Harvard in the early 1970s.

He said the Fed needs to start pulling back its bond-buying programs. Mr. Feldstein argued that a better formula for reviving the economy would be a combination of long-run deficit cuts through overhauled government benefits programs combined with short-run fiscal stimulus. Those are policies the Fed doesn't control.

"I do not expect bold policy initiatives from a Yellen Fed in the near term," said Christina Romer, a friend of Ms. Yellen's and former head of Mr. Obama's Council of Economic Advisers. "She has been a key architect of the current policies and so I would expect a great deal of continuity."

However Ms. Romer says the critics of the Fed's easy-money policies have it wrong. The Fed should have pushed the boundaries of easy money even more aggressively to get the economy back onto its precrisis footing quicker, she said. A more aggressive Fed might have jolted the expectations of households and businesses toward better times ahead and encouraged more growth in the near term. "It would take more than an incremental change in Fed policy to really change expectations and do a lot to boost growth," she said.

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# Fed Dials Back Bond Buying, Keeps a Wary Eye on Growth

##  Fed Dials Back Bond Buying, Keeps a Wary Eye on Growth

_By Jon Hilsenrath and Victoria McGrane_

_Dec. 18, 2013_

Ben Bernanke gave the U.S. economy a nod of approval just a month before he leaves the Federal Reserve, moving the central bank to begin winding down a bond-buying program meant to boost growth with the recovery on firmer footing.

The Fed has pulled back its stimulus efforts before, only to restart them when the economy disappointed, and new challenges loom, including a surprising slowdown in inflation. But Mr. Bernanke said in his final news conference as Fed chairman that the economy was getting to a point where it needs less help.

"Today's policy actions reflect the [Fed's] assessment that the economy is continuing to make progress, but that it also has much farther to travel before conditions can be judged normal," Mr. Bernanke said.

After months of wringing their hands about the implications of less Fed stimulus, investors resoundingly approved of the latest action to begin paring the $85 billion-a-month program. They were cheered in part because the move came with new Fed assurances that short-term interest rates would stay low long after the bond-buying program ends.

The Dow Jones Industrial Average finished the day up 292.71 points, or 1.84%, at a record 16167.97. Yields on 10-year Treasury notes rose, as often happened with signs of improving growth, to 2.885%. Asian stocks rose early Thursday.

"Today's decision by the Fed is a vote of confidence in the sustainability of the economic recovery," Beth Ann Bovino, chief U.S. economist at the bond-rating firm Standard & Poor's, said in a note to clients after the decision. She pointed to a batch of stronger economic reports for October and November, in addition to reduced political uncertainty.

A budget accord, approved by the Senate on Wednesday, lays the groundwork for federal tax and spending policies in 2014 that do less to restrict economic growth than they did in 2013.

The Fed, which launched the latest round of bond buying in September 2012 in a bid to fire up the tepid recovery, will now buy $75 billion a month in mortgage and Treasury bonds as of January, down from $85 billion. That will include $35 billion monthly of mortgage securities and $40 billion of Treasurys, $5 billion less of each. It will look to cut the monthly amount of its purchases in $10 billion increments at subsequent meetings, Mr. Bernanke said.

Although the Fed expects to keep reducing the program "in measured steps" next year, the timing and the course isn't preset. "Continued progress [in the economy] is by no means certain," Mr. Bernanke said. "The steps that we take will be data-dependent."

If the Fed proceeds at the pace he set out, it would complete the bond-buying program toward the end of 2014 with holdings of nearly $4.5 trillion in bonds, loans and other assets, nearly six times as large as the Fed's total holdings when the financial crisis started in 2008.

Still, officials--worried that investors would quake at the thought of less Fed support--went to lengths to demonstrate that they would keep interest rates low for years to come, even after the bond-buying program ends.

The Fed has said it wouldn't raise short-term rates, which are now near zero, until the jobless rate gets to 6.5% or lower. It was 7% in November. In its official policy statement Wednesday, the Fed said it would keep rates near zero "well past" the point when the jobless rate hits the Fed's 6.5% marker.

In official projections released by the central bank, the vast majority of officials said they expected to keep short-term rates near zero until 2015 or later, even though they see the jobless rate hitting 6.5% next year.

Mr. Bernanke's last day as chairman is Jan. 31. He will preside over one more policy meeting Jan. 28-29.

New challenges will confront his successor, Fed Vice Chairwoman Janet Yellen, who is expected to be confirmed by the Senate later this week to become the next Fed leader.

"She fully supports what we did today," Mr. Bernanke said when asked whether Ms. Yellen could be expected to carry forward the plan he laid out.

Perhaps the biggest immediate challenge the Fed faces is inflation, which has drifted far below the central bank's 2% objective. The Fed's preferred inflation gauge, the price index for personal consumption expenditures, increased just 0.7% in October from a year prior, the Commerce Department said earlier this month. Fed officials said in their statement Wednesday that they are watching the inflation situation carefully.

Slumping inflation could be a sign of building economic torpor, which officials want to avoid and could need to counteract with new easy-money policies. But if the Fed keeps current policies going too long, it could spark a new financial bubble.

The bond-buying program aims to lower long-term interest rates to encourage borrowers to spend and invest. While pulling back on it, the Fed is shifting toward relying more on providing verbal guidance to the public about where short-term interest rates are likely to be in the future. One reason for the shift: Officials are more familiar with managing short-term rates than long-term rates.

The Fed's growing emphasis on assuring low short-term rates comes with its own risks. Some economists believe the Fed erred between 2003 and 2006 when it also kept short-term interest rates low and provided investors with assurances rates wouldn't move up swiftly. The policy during that period might have led to too much risk-taking and borrowing, though economists disagree on that point.

In their latest economic projections, also out Wednesday, 12 of 17 Fed officials who participated in the policy meeting said they expected their benchmark short-term rate to be at or below 1% by the end of 2015. Ten of 17 officials expected the rate to be at or below 2% by the end of 2016.

On the decision to pull back on the bond-buying program, nine of the 10 voting members of the Fed's policy-making committee supported the move. Boston Fed President Eric Rosengren dissented because he believes that with the jobless rate still elevated and inflation running below the 2% target, changes to the bond-buying program "are premature until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate."

Mr. Bernanke parted with a few reflections on his eight-year tenure as Fed chairman. On several occasions he noted that the Fed has battled headwinds to the economy that have made its job more difficult, including the combination of government spending cuts and tax increases that slowed growth in the short run. He wanted that fiscal austerity spread out over a much longer period.

When asked about the budget deal that cleared the Senate Wednesday, Mr. Bernanke said it's "certainly a better situation" than in October, when budget battles resulted in a government shutdown and fears of a federal debt default. The Fed held off on reducing the bond program in September in part because of worries about the consequences of these fiscal battles.

He took some blame for failing to foresee the 2008 financial crisis that has dominated his tenure at the central bank. "Obviously, we were slow to recognize the crisis. I was slow to recognize the crisis," he said. "That said, we've done everything we could think of" since then to strengthen the financial system and economy.

He and his wife plan to stay in Washington for some time after he steps down, he said.

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# Rate Decision to Drive Yellen's Early Agenda

##  Rate Decision to Drive Yellen's Early Agenda

_By Jon Hilsenrath and Victoria McGrane_

_Feb. 2, 2014_

In three years as second-in-command at the Federal Reserve, Janet Yellen worried continuously about high U.S. unemployment and pushed for policies to bring it down. After she is sworn in as Fed chairwoman Monday a new question will almost immediately crowd her agenda: Why is unemployment falling so fast and what, if anything, should the central bank do about it?

The jobless rate was 6.7% in December and the Labor Department will release the January figure on Friday. Fed officials have said since December 2012 they wouldn't consider raising short-term interest rates from near zero until joblessness fell to at least 6.5%.

More recently, they have said they will keep rates low "well past" that point as they weigh other indicators the labor market remains weak. This suggests rate increases won't be coming soon even if joblessness were to touch 6.5% in Friday's report.

Among Ms. Yellen's most critical decisions is when to start lifting interest rates. If she and her colleagues wait too long, they could fuel high inflation or financial bubbles; if they move too soon, they could damp a recovery that is just gaining steam.

Key to that decision is making sense of the falling unemployment rate. She and other Fed officials worry it masks large pockets of stress still plaguing the labor market, including millions of people who want work but aren't looking anymore and therefore are no longer counted as unemployed.

"The U.S. labor market is incredibly complicated and trying to summarize it with one number is hard," says David Stockton, the former head of the Fed's research division. "They got themselves into a situation where they are using the unemployment rate but they see a considerable number of reasons why they believe it is not a sufficient statistic."

The fast descent in the jobless rate has caught Fed officials off guard. A year ago they didn't see it getting to 6.5% until 2015. As recently as June, they didn't see it reaching this point until sometime later this year.

A rule of thumb in economics known as Okun's Law suggests the jobless rate should fall a half percentage point for every percentage point the economy grows above its long-run trend rate. By that rule of thumb, the unemployment rate shouldn't have fallen much in an unusually anemic economic recovery. Instead it is down more than three percentage points from the recent peak.

One reason for the drop is an exodus of millions of workers from the labor force. In June 2009, when the recovery started, 81 million Americans said they weren't in the labor force, which means they weren't employed or actively looking for work, according to the government's labor force surveys. In December that number hit 92 million.

People are leaving the labor force for different reasons-- they're retiring, going back to school, joining disability rolls, giving up looking for jobs or doing other things--reducing the number of people counted as unemployed.

The trend raises hard-to-answer questions for the Fed. Will some of these people come back to work when the economy improves or have they left permanently? Do these shifts mean there is less slack in labor markets--workers available to take jobs--than they realized, or is the slack still out there, hidden in these numbers?

Ms. Yellen and other Fed officials equate slack with low wages and low inflation. If it is receding more quickly than they thought, rate increases might be needed sooner than planned. But they see many signs that the job market is still weak.

Nearly eight million people have part-time jobs but want full-time work. Another 2.4 million say they want jobs but aren't looking.

When taking into account these people and other "marginally attached" workers, the jobless rate is 13.1%.

Behind the numbers are people like Mialien Mack, 40, of Atlanta, Georgia. She was laid off in May from her marketing job in the corporate office of a convenience store chain in Atlanta after nearly 11 years with the company. She recently faced the expiration of her $330 per week of unemployment benefits, which has shifted her thinking about her job search.

"It's making me think, should I consider less money?" In her previous jobs she had been making the equivalent of about $25 an hour. Now she is contemplating positions that would pay half that. "Twelve-fifty is still not a livable wage for an adult with a child," she said. "However, is it a foot in the door?"

Downward pressure on wages is one of the big factors in the Fed's thinking about the jobless rate. So far, the falling unemployment rate has not fueled stronger wage gains or high inflation.

"Wage growth has been weak or non-existent in real terms over the last several years," Ms. Yellen said in her November confirmation hearing. Total compensation of workers, including benefits and wages, in the fourth quarter was up 2% from a year earlier, about the same as through the entire recovery, the Labor Department reported Friday. The Fed's preferred measure of consumer prices was up 1.2% in December from a year earlier.

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# THE PERSON: TRACING JANET YELLEN'S RISE

# THE PERSON: TRACING JANET YELLEN'S RISE

###

# Jobless Puzzle: Why Unemployment Sometimes Lingers On Stirs Renewed Interest

##  Jobless Puzzle: Why Unemployment Sometimes Lingers On Stirs Renewed Interest

_By Alan Murray_

_Dec. 25, 1985_

WASHINGTON--When George Akerlof was 11 years old, he worried about this: If his father lost his job, he would stop spending, causing someone else to lose a job, who would also stop spending, and so on until the economy crashed to a halt.

Fortunately, young George's theory was flawed. His father periodically did lose his job, but the economy survived.

That early intellectual misfire didn't discourage Mr. Akerlof, now an economist at the University of California at Berkeley, from continuing to think about unemployment. He and his wife, Janet Yellen, are members of a small band of maverick economists exploring new theories of joblessness. The group, which includes Joseph Stiglitz at Princeton and Lawrence Summers at Harvard, is pursuing ideas that eventually could help explain why unemployment stays high despite relatively healthy economic growth.

"It's one of the first theories to offer an intellectually coherent explanation of normal unemployment," says Kenneth Arrow, a Nobel-laureate economist at Stanford. "I think that's a very important development."

Unemployment has always puzzled economists. Classical theorists assumed that if the demand for goods fell, wages and prices would fall as well, restoring the balance in the economy and keeping everyone employed. Confronted with high unemployment during the depression, British economist John Maynard Keynes tried to modify classical theory. He and his followers argued in part that wages are "sticky" and slow to fall, causing at times a market imbalance that results in joblessness. But even the Keynesians couldn't explain adequately why joblessness would persist for long periods.

The new theories expand on Keynesian ideas. They say businesses may find it in their long-term interest to pay workers more than the market requires. By paying higher wages, they can increase worker productivity and their profits, these economists contend. As a result, wages stay too high, and the workings of the market can't assure everyone a job. Businesses stay competitive, but unemployment persists.

The path from abstract theory to practical economic policy is long and rugged. For example, many dismissed out of hand Mr. Keynes's unemployment theories when they were first published in 1936; a couple of decades later, his theories set the assumptions underlying government policies around the globe. As Mr. Keynes himself wrote, practical men may disdain academic theory but nonetheless "are usually the slaves of some defunct economist."

Whether the new theories will guide future policy makers is far from clear. The theories are young, and skeptics abound. "It's hard to say what their ultimate significance will be," says Robert Solow, a professor of economics at the Massachusetts Institute of Technology.

But the ideas are attracting some bright minds and seem to signal an important change in the direction of macroeconomics, the study of the economy's overall performance. After a decade of disillusionment, macroeconomists are focusing with renewed vigor on unemployment and other important problems. "I think we're in a very exciting period for macroeconomics," says MIT's Paul Samuelson, another Nobel laureate.

In the late 1970s and early 1980s, some academic macroeconomists began to doubt whether they had a role to play in public policy. Inflation and its effects seemed to shoot down many traditional Keynesian theories, and "supply-side" politicians and journalists dominated economic debates with their proposals to spur growth by cutting taxes. Many economists thought that "supply-side economics was silly from an academic point of view," contends John Taylor, a Stanford professor, and "serious macroeconomists felt blown out of the water."

Many academics turned away from policy problems and concentrated on sharpening their technical skills. "Rational expectations" theory became the rage. The theory emerges from the idea that individuals and businesses act rationally based on their expectations of the economy's future course. Based on this notion, young academics constructed complex mathematical models of economic activity.

However, these models rarely bore much resemblance to reality. Among other things, they reverted to the classical idea that Adam Smith's "invisible hand" would guarantee all willing workers a job. Unemployment was assumed to be "voluntary." The government's jobless figures, many of these economists say, measure only "the demand for leisure."

But while legions of young economists were ignoring unemployment in their theoretical formulations, the rest of society was watching the jobless rate climb to postwar highs. Even today, after three years of expansion, unemployment still hangs at 7%, a level widely deemed intolerable only a decade ago. Rational expectationists, Mr. Solow complains, were like biologists who, unable to understand how giraffes' hearts could pump blood up such long necks, concluded that giraffes don't have long necks. The new theorists reject the rational-expectations view that most unemployment is voluntary as "just nonsense," Ms. Yellen says.

Classical economists, trained in free-market theory, have always found it difficult to understand why, in the words of economist Robert Hall at the Hoover Institution, "the labor market doesn't behave like the onion market." When the supply of onions exceeds the demand for onions, prices fall. But when the supply of labor exceeds the demand for labor--that is, when there is unemployment--wages don't always fall.

In a free market, classical economists argue, a company shouldn't be able to pay workers more than the going wage for a prolonged period. If Ace Widget Co. offers its workers $5 an hour when workers who seem equally qualified are willing to work for $3 an hour, another widget entrepreneur will seize the bargain and drive Ace out of business.

But the new theory--known as "efficiency wage theory"--provides a possible answer as to why a company may pay more than the market requires. If Ace Widget employees work harder because they are paid more, then low-wage companies may not be able to compete with Ace. Wages remain higher than necessary, and the result is persistent unemployment. The traditional free-market story breaks down. "Adam Smith's invisible hand turns out to be a little bit palsied," Mr. Stiglitz says.

Harvard's Prof. Summers is one of the newer converts to the efficiency-wage theory. Though only 30 years old, he is already considered one of the bright new lights in economics. He introduces the theory to a group of New York University graduate students with this story:

In 1914, in the midst of a recession, Ford Motor Co. made a startling decision to raise its wage for industrial workers to $5 a day. At the time, prevailing daily wages at other companies ranged from $2 to $3. Ford's announcement lured to its gates thousands of people hoping for a job.

Conventional economic theory suggested that the move would prove disastrous. But Henry Ford insisted that it was good business. In a history of Ford Motor, Alan Nevins writes that the dramatic move had "improved the discipline of the workers, given them a more loyal interest in the institution and raised their personal efficiency."

Scribbling a mathematical model on the blackboard to explain this change in attitude, Mr. Summers says companies pay above-market wages to keep employees from neglecting their work. Unable to monitor workers closely, a company can catch only a fraction of those who shirk. If the company pays the "market-clearing" wage that traditional theory suggests, a worker risks little by shirking; if caught, he faces only temporary discomfort before finding another job at the going wage.

But if the company pays higher wages, the shirker's risks rise; if caught, he may face a long bout of unemployment while seeking an equivalent job or he may end up in a lower-paying job.

At Berkeley, Mr. Akerlof and Ms. Yellen have developed a somewhat different brand of the efficiency-wage theory based in part on insights that Mr. Akerlof gathered from sociological studies.

For an economist to use sociology in his work, Ms. Yellen says, is a bit like "wearing a loud shirt." Economists view people as motivated by rational, economic concerns; sociologists are more likely to delve into the irrational. Hoover's Mr. Hall reflects the attitude of most of his colleagues in saying he stops reading whenever he sees the word "sociological" in an economics paper.

Mr. Akerlof defends his efficiency-wage work. "With a little sociology, it's very easy to show how unemployment occurs," he says. In recent years, he has been reading sociological studies of "gift exchange," and he believes that in them he has found a convincing explanation of why companies pay higher wages than the market requires.

Mr. Akerlof argues that an employee's effort depends partially on the "norms" of the group in which he works. By paying workers a "gift" wage in excess of the minimum required, a company can raise group norms and get back a "gift" of extra effort. The theory also helps explain why companies may not fire or pay lower wages to less productive workers. Such moves would undermine the morale of all of a company's workers and reduce productivity.

In many ways, Princeton's Prof. Stiglitz is the father of efficiency-wage theories. A classmate of Mr. Akerlof's at MIT, Mr. Stiglitz began thinking about such theories during a visit to Kenya in 1969. Economists studying underdeveloped countries had for some time realized that higher wages could make workers more productive by improving their nutrition. But Mr. Stiglitz suspected that a related phenomenon might explain unemployment in the developed world.

By paying above-market wages, he reasons, a company might be able to reduce turnover and cut training costs. And he has studied the possibility that companies may pay higher wages to improve the quality of their employees. Unable to assess fully the skills of each potential employee, a company may improve the odds that it will get and retain good workers by paying more money.

"Any of these explanations by themselves may seem a little shaky," he says. "But I think the truth may be a complicated interaction of all of them."

Many prominent mainstream economists doubt that the theories are as important as their promoters claim. Although the theories may convincingly explain why, under normal circumstances, unemployment might exist, they fail to explain the wide swings in unemployment set off by recessions.

"The efficiency-wage theories provide reasons why there might be people who can't get jobs at the going wage rate," says William Nordhaus, a Yale economist. "But I'm a little skeptical as to whether they resolve the basic issues" of cyclical unemployment.

The new school is addressing this problem. Prof. Stiglitz, for example, says efficiency-wage theories can begin to explain cyclical unemployment by taking account of the fact that workers' productivity depends partly on the wages they are paid relative to those paid by other companies. But Prof. Summers admits, "I don't think we're all the way there, by any means, in providing an explanation of cyclical unemployment."

Nevertheless, the theories could have important implications for government policies. By debunking the notion, now popular in Washington as well as academia, that unemployment is largely voluntary, the efficiency-wage theory could support the case for more generous unemployment compensation.

In addition, Mr. Stiglitz says, the theory could be used to combat arguments against the minimum wage, which many traditional economists decry as tending to increase unemployment by keeping wages above the market level. The efficiency-wage theory suggests that companies may find it in their interest to pay above-market wages. Mr. Stiglitz also argues that a better understanding of the causes of unemployment could suggest new tax policies to encourage employers to hire the jobless. And Mr. Summers has written that efficiency-wage theory could justify an "industrial policy" of subsidizing high-wage companies.

But Mr. Summers adds that such policies present "practical" problems. And, along with Mr. Stiglitz, Mr. Akerlof and Ms. Yellen, he refrains from advocating any immediate policy change. "Policy is always several years behind theory," he says, "and it's a damn good thing it is."

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# Clinton Selects Two Economists For Posts at Fed

##  Clinton Selects Two Economists For Posts at Fed

_By David Wessel_

_April 25, 1994_

WASHINGTON--President Clinton picked two economists with distinguished academic pedigrees for the Federal Reserve Board, hoping they can persuade the Fed to increase its emphasis on growth.

Mr. Clinton, as expected, said he will nominate Alan Blinder, of his Council of Economic Advisers, and Janet Yellen, of the University of California's Haas School of Business at Berkeley, to the seven-member board. Mr. Blinder would become the board's vice chairman.

The nominations come as the Fed has begun to raise short-term interest rates, arguing that it must move now to prevent an increase in inflation. Neither the central bank nor the White House wants the economy to grow so fast that the Fed will slam on the brakes and provoke a recession before the 1996 election. But there are bound to be differences about how much growth is too much, and about how high interest rates need to go to minimize the inflation risk. Mr. Clinton's advisers sought nominees who, by intellect and personality, might influence Fed Chairman Alan Greenspan to lean toward somewhat more growth.

Introduced at the White House by Treasury Secretary Lloyd Bentsen Friday, Ms. Yellen described herself as "a nonideological pragmatist" and spoke of the contribution that "a predictable, well-executed monetary policy can make to economic growth." Mr. Blinder, quoting Mr. Greenspan, pledged the Fed will continue to aim for "sustainable, non-inflationary growth." Talking to reporters later in the day, he said that "signs of an imminent acceleration of inflation just aren't there."

But in contrast to Reagan and Bush appointees to the Fed, both Mr. Blinder and Ms. Yellen are from the liberal, Keynesian wing of economists. Neither is likely to be an ally of those at the Fed whose top priority is reducing the inflation rate below today's moderate level. "They're both first-rate economists, somewhat more concerned with growth than worried about future inflation," said Michael Boskin, who was President Bush's top economic adviser. "I'd expect their appreciation of the importance of keeping inflation low and stable to grow in their new jobs."

Mr. Blinder, who once described himself in print as an "inflation dove," wrote in 1987 that "the low and moderate inflation rates experienced in the U.S." are "more like a bad cold than a cancer on society." Extending the metaphor in an interview earlier this year, he added, "If you don't have a cold, you certainly don't want to contract one. That's the Fed's current job."

Ms. Yellen's writings are less quotable--to the relief of Mr. Clinton's economic advisers. But she is a protege of Yale University economist James Tobin. Mr. Tobin, a Nobel laureate who is among the Greenspan Fed's toughest critics, said earlier last week that Ms. Yellen "will have a very salutary influence" on the Fed.

The two nominees can't outvote the 10 other members of the Fed's policy committee. But Presidents Reagan and Bush demonstrated that two new voices can alter Fed policy. In late 1991, for instance, the pace of Fed interest-rate cuts accelerated after two Bush appointees arrived.

Mr. Blinder, 48 years old, wasn't among Mr. Clinton's inner circle during the presidential campaign. But--in the president's words--he emerged "as an economic conscience in my administration striving to ensure that our policies met the test of rationality and workability." Former Fed Vice Chairman David Mullins called the nomination "excellent," praised Mr. Blinder's "stature, ability and intellectual integrity" and said he was confident Mr. Blinder "understands the important role of the central bank in keeping inflation in check."

Mr. Blinder earned a doctorate at the Massachusetts Institute of Technology and taught for more than 20 years at Princeton University before taking the White House job.

Ms. Yellen, 47, earned her doctorate at Yale and taught at Harvard and the London School of Economics before joining the Berkeley faculty in 1980. She worked as an international economist on the Fed staff in Washington in the late 1970s. Her husband, George Akerlof, is a prominent macroeconomic theorist.

Mr. Blinder would fill Mr. Mullins's term on the Fed, which expires in January 1996. Ms. Yellen would succeed Reagan appointee Wayne Angell for a full 14-year term.

In a statement, Mr. Greenspan said that he has been "singularly impressed with Mr. Blinder's capabilities" and that, though he hasn't worked with Ms. Yellen, he found her credentials "clearly impressive."

Mr. Greenspan's term as Fed chairman expires in March 1996. If Mr. Greenspan isn't reappointed, Mr. Blinder could be a contender for the post. Other possibilities include Robert Rubin, head of Mr. Clinton's National Economic Council, and Gerald Corrigan, former president of the New York Federal Reserve Bank.

The nominations of Mr. Blinder and Ms. Yellen are subject to Senate confirmation.

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# Back to the World: Berkeley's Economists Attack Policy Issues With Unusual Gusto

##  Back to the World: Berkeley's Economists Attack Policy Issues With Unusual Gusto

_By Thomas T. Vogel Jr._

_Nov. 30, 1995_

BERKELEY, Calif.--Activists have taken over at Berkeley, again.

The school that was synonymous with 1960s tie-dyed radicalism is once more in the vanguard. This time it's shaking up the economics profession, and the rebels are on the faculty, the 42 Ph.D.s in the Department of Economics at this University of California campus.

Their battle cry is "real-world economics," and they talk and write about today's hot-button issues, such as jobs and wages, immigration policy, the dollar and currency markets, business cycles and technology's role in economic growth. While intellectually rigorous, many of their pursuits are a sharp departure from the esoteric realms of many academic economists, who churn out papers strewn with Greek-letter formulas understood by few and interesting to even fewer.

The Berkeley economists' focus on policy issues has turned the school, which nearly sank into obscurity a dozen years ago, into one of America's most influential. Nearly a quarter of the economics faculty has gone on leave to Washington in the past two years. With so many professors ladling out so much advice, Berkeley has become a formidable challenger to economic-policy power centers such as Harvard, Princeton, Chicago and Stanford. And with Berkeley's Laura Tyson now heading President Clinton's National Economic Council, the university seems to some observers like a hotbed of managed trade and other Clinton-administration enthusiasms.

Many others, however, contend Berkeley doesn't show the ideological fervor of, say, the University of Chicago and its laissez-faire approach. What distinguishes most Berkeley economists, by contrast, is a willingness to get their hands dirty. Theory is important, they say, but not in and of itself. The application of theory to real-world problems most interests them, and this attitude pervades the school.

Other top universities are trying to steal Berkeley's real-world thunder by hiring away some of its brightest stars. "I spent three years fending off raids from other top-ranked schools," including the University of Pennsylvania, Chicago, Harvard, Yale and Princeton, says John Quigley, who finished a stint as department chairman this summer.

Some noted economists view Berkeley's real-world emphasis as possibly the start of a trend--one long overdue. Nobel laureate James Tobin of Yale sees signs of a "pendulum swing" back to earlier concerns. "Sometimes the methodology that was developed in the last 20 to 25 years gets in the way," he says.

Typifying Berkeley's new breed is Alan Auerbach, who was recruited from the University of Pennsylvania last year to start Berkeley's Burch Center on Tax Policy and Public Finance. Mr. Auerbach says he moved partly out of disappointment with the way many economics faculties have become increasingly divorced from real problems and do a lot of theoretical work that "may bear very little relationship to the world we live in."

At Berkeley, a faculty member isn't looked down on for both being active in policy making and doing scholarly research, "as you can see from the number of Berkeley people in Washington right now," Mr. Auerbach says. At many schools, he complains, "it was becoming difficult for a newly minted economist to become what I would view as a well-rounded scholar." Mr. Auerbach was the deputy chief of staff of Congress's Joint Committee on Taxation in 1992 and is now on a National Research Council panel on the economic and demographic effects of immigration.

Among other Berkeley economists getting their hands dirty are Janet Yellen, a Federal Reserve governor who has an appointment at the university's business school, and her husband, George Akerlof, who divides his time between the Brookings Institution in Washington and a class he teaches at the school. Michael Katz is chief economist at the Federal Communications Commission. Richard Gilbert recently finished a stint in the Justice Department, where he played a key role in the Microsoft Corp. antitrust case. He was replaced by Carl Shapiro, another Berkeley faculty member. And when Ms. Tyson headed the President's Council of Economic Advisers, she brought several other Berkeley economists to Washington to serve on the CEA staff. "At one point I thought we should have department meetings out there," Mr. Gilbert jokes.

In addition, many Berkeley faculty members have taken on influential work outside the Beltway. Christina Romer has done research debunking the notion that U.S. business cycles are becoming less volatile, and Paul Romer (no relation) has written extensively about the role of technology in spurring economic growth.

Noting the school's "powerful influence," Ms. Tyson says a lot of the ideas influencing "the first part of this administration and certainly throughout our trade policy and our technology policies actually had their birth in Berkeley" or were studied closely at the school.

Not surprisingly, some economists don't agree that the profession has become too theoretical. One is Chicago's Robert Lucas, who won a Nobel Prize this year for his theoretical work on rational expectations and was a member of an American Economics Association panel that produced a report on graduate economics programs in the U.S. At the end of a section of that 1991 report, about how the programs seemed to screen out students weak in advanced mathematical skills more readily than those weak in undergraduate economics skills, Mr. Lucas asked, "Why is it regarded as a concern?"

He says the report exaggerated "the amount of math that is being required to make it seem excessive" and provided no hard evidence to back this criticism.

But his colleagues who helped assemble the report, including Alan Blinder, the vice chairman of the Federal Reserve but then a professor at Princeton, were concerned nonetheless. An "underemphasis" on the links between economic tools and real-world problems "is the weakness of graduate education in economics," the report concluded. Graduate "programs may be turning out a generation with too many idiots savants, skilled in technique but innocent of real economic issues."

At one unnamed "leading" university, graduate students couldn't "figure out why barbers' wages have risen over time," but they could easily "solve a two-sector general equilibrium model with disembodied technical progress in one sector," the report noted.

Things haven't changed very much since the report came out.

"The economics profession is really in wonderland," says Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis. "I have tried several times to hire Ph.D. students. They knew everything about rational expectations but not about economic forecasting or how the financial system works."

Just a dozen years ago, Berkeley graduates tended to be a bit short on reality, too. In the 1960s and 1970s, the school was considered a center of high-brow theory; in 1983, Berkeley's Gerard Debreu won a Nobel for theoretical work on how prices operate to balance supply and demand. But by then, the school was no longer ranked among the top 10, or perhaps even the top 20, graduate economics programs in the U.S. In a 1981 review, a group of outside economists said it was "a shame that the status of the Department of Economics has deteriorated over the last 20 years on the Berkeley campus."

Part of the problem was an odd polarization of the department, which in the late 1970s was top-heavy with professors near retirement age. In one camp was a group of theorists, ensconced in Evans Hall, and in the other, macroeconomic generalists and historians, across the campus in Barrows Hall. At times, the macroeconomists called the theorists mathematicians, and the theorists called the macroeconomists sociologists; neither group thought the other was doing real economics.

The schism was perpetuated by longtime professors in both camps who tended to vote in blocs for job candidates who specialized in their favorite fields. "It was discouraging," says Jeffrey Frankel, who joined the faculty in 1979 but contemplated leaving just five years later.

But after the 1981 review and a number of others, the faculty began hiring in a wider range of specialties. Later, the university bought out a number of tenured professors as part of a schoolwide cost-cutting program. The result: a flood of young blood and a dramatic drop in the faculty's average age from the 60s to somewhere between the early 40s and early 50s. About 80% of the current faculty wasn't around in 1979--a huge turnover in academia. Once again, Berkeley is considered one of the top five to seven economics faculties nationally. And, of course, it hardly neglects theoretical work now. Last year, Berkeley's John Harsanyi shared a Nobel for his work on game theory.

But the faculty's changed character is typified by the Colloquium for Research on International Politics and Economics. The interdisciplinary seminar, led by Mr. Frankel, invites experts to discuss current issues ranging from U.S. trade policy to developing nations' debts.

Last month, nearly two dozen students and professors sipped soda, nibbled sandwiches and discussed the Mexican currency crisis. They heard Bradford De Long, a U.S. Treasury official during the crisis, and Professors Frankel and Barry Eichengreen, experts in international economics, give a play-by-play review and analysis. Handouts included a copy of the Treasury Department's press release for the $50 billion financial-support package to keep Mexico from defaulting on its debt.

Mr. De Long, an expert on financial markets who played an advisory role on the package, told how he stopped what he considered a serious misstep: The Treasury's public-relations aides planned to try to drum up lobbying support for the package by telling some businesspeople about it before most others were informed.

"I made a sprint down the hall to stop them," he said.

Such experiences color many Berkeley professors' attitude toward policy issues. "You come back from Washington in one of two moods," Mr. De Long says. "The first is hopelessness: Let me work on something abstract and avoid economic policy completely. The second is: My God, there is so much to be done!"

Berkeley's real-world emphasis also extends to the undergraduate introductory course taught by Christina Romer. She kept the attention of 900 students packed into an auditorium recently by making fun of the artificial examples in the textbook. She also sprinkled references to the 1970s oil crisis and other events into her discussion of shifts in short-run supply curves. Then, she asked the students for a few real-world examples of their own. "I hate textbooks, so there are no `widgets' in my course," she said after the class. "Why make things up when there are so many interesting things going on?"

The changes seem to attract better students. The percentage of publishable papers produced in one graduate course has risen to 50% from 10% in four years, notes Daniel McFadden, the department's current chairman. "That's an awful lot." And Fabio Ghironi, a graduate student who turned down nine other schools, including Chicago, Yale and Minnesota, to come to Berkeley, says, "I want to be an international economist and do theory and find some way to apply it to reality. I don't want to be only a theorist."

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# Janet Yellen, a Top Contender at the Fed, Faces Test Over Easy Money

##  Janet Yellen, a Top Contender at the Fed, Faces Test Over Easy Money

_By Jon Hilsenrath_

_May 12, 2013_

The next chief of the Federal Reserve will decide when to reverse the easy-money policies of Ben Bernanke, a judgment that could strangle the economic recovery if made too early or trigger runaway inflation if made too late.

The task could fall to Fed vice-chairwoman Janet Yellen, a meticulous and demanding Yale-trained economist, who issued prescient, early warnings about the housing bust. After the financial crisis, she helped focus the Fed on jobless Americans, with policies aimed at stimulating the economy at least until unemployment falls to 6.5%.

Ms. Yellen is a top contender for the job, assuming Mr. Bernanke steps down when his term ends in January, but her selection is far from certain. She faces a big question among investors: Is she wary enough about the risks of easy money to close the Fed's credit spigot before financial bubbles emerge or consumer prices rise too far? As a first step, Fed officials have mapped out a strategy that maintains flexibility for winding down its $85 billion-a-month bond-buying program intended to spur the economy. But the timing of the withdrawal is still being debated.

"I am worried that the approach that she and many others favor does over time allow the Fed's anti-inflation credibility to erode," said Alfred Broaddus, former president of the Federal Reserve Bank of Richmond.

Born in Brooklyn to parents who lived through the Great Depression, Ms. Yellen, age 66, has called for the Fed to respond aggressively to high unemployment. She argued after the financial crisis that inflation wasn't likely to emerge with the economy in such a debilitated state--a correct view, so far. Inflation has since averaged 1.8% a year.

"These are not just statistics to me," she said in a speech to the AFL-CIO labor union group in February. "We know that long-term unemployment is devastating to workers and their families."

Richard Trumka, the union president who invited her to speak, said the U.S. would be "well-served" if Ms. Yellen succeeded Mr. Bernanke. "She understands the plight of Wall Street and workers, not just Wall Street," he said.

But she has met resistance among others inside and outside the Fed. James Bullard, the president of the St. Louis Fed, said in an interview that if the central bank tried too hard to bring down unemployment, it might uncork inflation without doing much to foster jobs.

"A lot of people are talking about putting more weight on unemployment," he said, without citing Ms. Yellen directly. "I don't think it's a good idea."

Whoever is nominated by President Barack Obama for the post is likely to face close scrutiny in Senate confirmation hearings.

Sen. Richard C. Shelby of Alabama, a top Republican on the Senate Banking Committee, voted against her confirmation as vice chairwoman in 2010, accusing her of "inflationary bias."

Among private economists surveyed last week by The Wall Street Journal, 29 of 38 said they expected Ms. Yellen to get the job. Other candidates could include former Fed vice chairman Roger Ferguson and former Treasury secretaries Timothy Geithner and Lawrence Summers.

"If I were in the White House I would relish the idea of nominating the first female Fed chairwoman, with a resume that is potentially better than the current Fed chairman," said Vincent Reinhart, Morgan Stanley chief U.S. economist and former head of the Fed's monetary affairs division.

Still, he said, "I think market participants are nervous about her," pointing to the concern that she would weight employment over inflation. "Look at the AFL-CIO speech."

Ms. Yellen impressed Mr. Obama when he sought her advice as a presidential candidate, but they aren't close, according to people who know them. When she was nominated for Fed vice chairwoman, for example, she didn't have a face-to-face interview with Mr. Obama, according to people familiar with the matter.

Mr. Geithner and Mr. Summers, by contrast, have strong White House ties. Mr. Geithner has said he doesn't want the job; Mr. Summers is interested, according to people who know him, but he declined to comment.

While Mr. Bernanke doesn't appear to want a third term as Fed chairman, the president could press him to stay. Mr. Bernanke said in March he had discussed his plans "a bit" with Mr. Obama but declined to say more. The White House hasn't disclosed how the president will choose.

The selection involves more than political drama. The Fed could be entering another perilous period. The central bank has pushed short-term interest rates to near zero, launched bond-buying programs that pumped trillions of dollars into the economy and left its own $3 trillion securities portfolio swollen with mortgage-backed and Treasury securities.

At some point, the next Fed leader will need to use untested methods to reverse the process, raising interest rates and siphoning up huge volumes of cash from banks. "They will be learning as they go," said Laurence Meyer, a former Fed governor.

Ms. Yellen's supporters say there are few better prepared students. She was class valedictorian at Fort Hamilton High School in a middle-class Brooklyn neighborhood. Her father was a doctor who worked out of the basement of the family's brownstone. Her mother, who quit an elementary school teaching job to raise two children, drove him to house calls and managed the family's finances--tucking away savings and tracking stock prices from the afternoon newspaper in small, neat handwriting, said Ms. Yellen's brother, John.

"My parents held us to high academic standards," said John Yellen, the archaeology program director at the National Science Foundation. After dinner, he recalled, they listened to radio programs, including the adventure series, "Sergeant Preston of the Yukon."

Ms. Yellen got interested in economics in college. While an undergraduate at Brown University, she was impressed with a talk by visiting Yale professor, James Tobin, who would later win a Nobel Prize in economics. She decided to pursue an economics Ph.D. at Yale, where her interest in unemployment grew while working with Mr. Tobin, her mentor and dissertation adviser.

Mr. Tobin, a child of the Depression and an adviser to presidents John F. Kennedy and Lyndon B. Johnson, emphasized the human toll of high unemployment and the government's obligation to combat it. He was so impressed with her meticulous notes of his lectures that he asked her to turn them into a textbook. She left to teach at Harvard and didn't complete the book.

Willem Buiter, Citigroup's chief economist, said Ms. Yellen's notes were like the Old and New Testament for Yale Ph.D. students when he studied there in the 1970s. "She was a legend when I arrived at graduate school," said Richard Levin, Yale's president, who used them to study in the1970s.

Ms. Yellen went to work on the Fed staff in the fall of 1977, where she met her future husband, economist George Akerlof. They married the following June. "Not only did our personalities mesh perfectly, but we have also always been in all but perfect agreement about macroeconomics," he wrote in an autobiography after he won the 2001 Nobel Prize for economics. Their son, Robert Akerlof, is an economist teaching at the U.K.'s University of Warwick.

Her husband is skeptical of markets. In a talk at last year at Warwick, he said, "the public and economists have too great an acceptance that whatever markets do is right."

Ms. Yellen climbed the Fed ranks by being methodical rather than iconoclastic. She shows up at policy meetings with carefully crafted statements. Those who work with her say she arrives at the airport hours early.

During the mid-1990s, then-Fed chairman Alan Greenspan asked her to take the lead in an internal Fed debate about whether to adopt a formal inflation target. Her preparation impressed others. "She does her homework," said Mr. Broaddus, her chief adversary in the debate.

During the discussion Ms. Yellen challenged Mr. Greenspan, who was rarely confronted, to define his views of price stability, according to Fed transcripts and people there. Later, as the economy strengthened, she worried about the booming stock market and also urged Mr. Greenspan to raise short-term interest rates to head off inflation--advice he declined, according to Mr. Meyer, her colleague at the time.

Ms. Yellen became chairwoman of the Council of Economic Advisers under President Bill Clinton in 1997, a period of strong economic growth. She and Clinton adviser Gene Sperling danced with their hands in the air at a 1999 White House staff meeting in the Roosevelt Room when the jobless rate fell near 4%, according to people at the meeting.

Later, as president of the San Francisco Fed, Ms. Yellen sounded early warnings about the danger of a U.S. housing bust. "I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector," she said at a June 2007 policy meeting, according to Fed transcripts. "The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst."

Three months later, she foresaw a dangerous economic cascade.

"A big worry is that a significant drop in house prices might occur in the context of job losses, and this could lead to a vicious spiral of foreclosures, further weakness in housing markets, and further reductions in consumer spending," she said, at a September 2007 meeting. "The potential effects of the developing credit crunch could be substantial."

In December, she called on the Fed to cut interest rates aggressively, according to Fed transcripts. Mr. Bernanke chose a more cautious approach--until a month later, when conditions worsened.

Shortly after the Fed rescued Bear Stearns Cos. in March 2008, Mr. Obama--then a senator and presidential candidate--called Ms. Yellen. He wanted explanations of the unfolding financial turmoil and she was among a few people he asked, said Austan Goolsbee, an Obama adviser who arranged the call.

Ms. Yellen, a Democrat, impressed Mr. Obama during a 30-minute conversation as she explained the risk of modern-day bank runs at Wall Street firms spreading like wildfire through markets, Mr. Goolsbee said.

She has ruffled feathers at the Fed with her strong views, but the central bank in the past three years has moved toward her prescription of sustained aggressive action.

As Fed officials deliberated last April about how long to keep interest rates low, Ms. Yellen delivered a20-page speech, with 18 footnotes and 15 charts, making the argument that rates should stay low until 2015 or later. The speech, later praised by Mr. Bernanke, presaged a shift by the Fed toward making clear its intentions to keep rates down longer than previously planned.

"She argues very effectively," Charles Evans, president of the Chicago Fed said in an interview. "She is constantly asking you to think about the argument that you have put on the table, especially when it is at variance with other facts. People look to her and liste7n to what she's saying."

While the Fed's second-in-command traditionally stands in the shadow of the chairman, Ms. Yellen has been outspoken. Mr. Bernanke was closer personally to Ms. Yellen's predecessor, Donald Kohn, another potential successor, who formed a bond with the chairman during the crisis, said people who know them.

Still, Mr. Bernanke and Ms. Yellen largely see eye-to-eye. "I can't see a material difference between them," said another central banker who has seen them often at international meetings in Basel, Switzerland.

Last year, Ms. Yellen ran a Fed committee that crafted a document detailing how the Fed viewed its so-called dual mandate, the central bank's focus on both inflation and unemployment, as set by Congress.

The document for the first time made a formal 2% inflation target, a goal of both Mr. Bernanke, as well as inflation hawks--those who worry most about keeping prices stable. It also laid out markers for unemployment rates, which the hawks resisted.

Officials haggled over the 531-word document for months, according to people involved in the discussions. The Fed directly controls inflation through its management of the money supply, but many factors influence unemployment. Officials were wary of promising too much on hiring, and they struggled to define how they would balance job goals with inflation.

The document illustrated Ms. Yellen's view of Fed operations. As long as inflation was running below 2%, she argued, the Fed could afford to keep money flowing, helping bring down unemployment.

Ms. Yellen also pushed for more than a year behind the scenes for another step to signal the Fed's commitment to low rates, said people involved in the debate. In December, following the advice of her and Mr. Evans, the central bank promised to keep short-term interest rates near zero until the jobless rate falls to 6.5%, as long as inflation doesn't threaten to rise any more than a half-percentage point above the 2% goal.

The moves create a framework for an exit plan: As the job market improves, the central bank will gradually stop its bond buying. Later, after unemployment falls to 6.5% or lower, the Fed will start raising short-term interest rates.

If inflation ticks up, it might move sooner. Eventually, the Fed could sell some of its bonds and begin soaking up all that cash.

It will be up to the Fed's next leader to prove the plan will work.

###

# THE BATTLES: FIGHTS OVER POLICY, MANAGEMENT AS YELLEN ROSE

# THE BATTLES: FIGHTS OVER POLICY, MANAGEMENT AS YELLEN ROSE

###

# Senators Confirm Yellen For Fed

##  Senators Confirm Yellen For Fed

_By Kristina Peterson and Pedro Nicolaci da Costa_

_Jan. 7, 2014_

Janet Yellen will join the ranks of the most powerful economic policy makers in the world next month, taking the helm of the Federal Reserve at a time when the central bank is assessing its unprecedented steps to buoy the U.S. economy.

The 67-year-old Ms. Yellen, currently the vice chairwoman of the Fed's board of governors, will become the first woman to lead the central bank in its 100-year history after the Senate voted to confirm her Monday night in a 56-26 vote. Eleven Republicans joined 45 Democrats to support her; no Democrats opposed her. Weather-related travel problems caused some lawmakers to miss the vote.

Expected to assume office on Feb. 1, Ms. Yellen will immediately be forced to grapple with questions over whether the economy that is on the mend can withstand further dialing back of the Fed's latest bond-buying program, which she has championed. If the Fed moves too fast, it could cool the recovery. If it moves too slowly, it could fuel asset bubbles or excessive inflation. The Fed cited improvements in growth and employment in December when it decided to trim its bond buys to $75 billion a month from $85 billion.

Senate Democrats said Monday they expected Ms. Yellen to keep a vigilant eye on the financial system to prevent the kinds of systemic failures that sent the country into a deep recession.

"It is more important than ever that we have strong regulators like Governor Yellen who can recognize emerging threats to economic stability," Sen. Sherrod Brown (D., Ohio) said on the Senate floor on Monday shortly before the vote. "In confirming her, we can look forward to a new era of recovery and growth."

But Ms. Yellen will begin her term facing the skepticism of congressional Republicans, many of whom have expressed concerns over potential risks embedded in the Fed's bond-buying programs and pressed for more congressional oversight of the central bank's monetary-policy decisions.

"As chair, she's likely to continue these same easy-money policies with the same, if not more, vigor than [her] predecessor," said Sen. Charles Grassley (R., Iowa), who opposed her.

The Fed declined to comment.

Her ascension to the Fed's top spot followed an unusually bitter and public nomination fight last year, when Democrats urged President Barack Obama to choose her over former Treasury Secretary Lawrence Summers. Following the infighting over Mr. Summers, Democrats quickly unified around Ms. Yellen, praising her years of experience at the Fed.

Since the financial crisis, Senate votes and debates on Fed nominations have become increasingly tense, reflecting the controversy around the central bank's easy-money policies aimed at supporting the U.S. economic recovery. Thirty lawmakers opposed current Fed Chairman Ben Bernanke's nomination to a second term in January 2010.

Mr. Bernanke will preside at the Fed's policy meeting Jan. 28-29. His last day as chairman is Jan. 31. Ms. Yellen is expected to be sworn into office Feb. 1 and lead the Fed's policy meeting in March.

Ms. Yellen will face numerous challenges, including winding down the Fed's easy-money policies as the economy picks up, forging consensus within a fractious policy committee, honing her public communication skills and keeping a divided Congress informed on policy.

Ms. Yellen has emphasized the Fed's role in bringing down unemployment during times of economic strain. She has been a strong supporter of the central bank's current bond-buying program, which aims to bolster economic growth by lowering long-term interest rates in an effort to encourage spending, hiring and investment.

U.S. job growth has picked up recently to a pace of close to 200,000 a month, while the unemployment rate has fallen to 7% from above 8% before the Fed launched the latest round of its bond-buying program in September 2012.

The Fed will want to spur continued progress in the labor market. Policy makers stressed in December that future reductions in bond purchases will be incremental and hinge on further gains.

Once the group agrees on what to do, Ms. Yellen will be the one to explain the policies and thinking to the markets, Congress and the general public. She is an experienced public speaker, having been the Fed's vice chairwoman since 2010 and head of the San Francisco Fed for six years before that. But she prefers meticulously prepared presentations to extemporaneous public speaking.

Meanwhile, the Senate delayed a procedural vote until Tuesday on a three-month extension of extended unemployment benefits.

###

# Yellen Would Bring Tougher Tone to Fed

##  Yellen Would Bring Tougher Tone to Fed

_By Jon Hilsenrath_

_Sept. 22, 2013_

Janet Yellen, the lead candidate to succeed Federal Reserve Chairman Ben Bernanke, brings a demanding and harder-driving leadership style to the central bank, in contrast to Mr. Bernanke's low-key and often understated approach.

Ms. Yellen, the Fed vice chairwoman, is highly regarded by many central bank staff members, who call her an effective leader with a sharp mind. But she has clashed with others and left some hard feelings in the wake of those confrontations, according to interviews with more than a dozen current and former staff members and officials who worked with her directly in recent years.

Most agree that Ms. Yellen--who has climbed the ranks from Fed researcher to Fed governor and regional Fed bank president, in between stints outside the central bank--is exacting and exceptionally detail-oriented.

At Fed policy meetings, Ms. Yellen is courteous, respectful, serious and meticulously prepared, according to officials who have attended meetings with her. She has staked out strong positions in favor of the Fed's easy-money policies that sometimes put her at odds with opponents of the policies, these people said.

When Lawrence Summers, the former U.S. Treasury secretary, was seen as the favorite to succeed Mr. Bernanke next year, his sometimes-combative style received substantial attention. Ms. Yellen often was described as milder-mannered and better at building consensus.

Mr. Summers announced a week ago he was pulling out of consideration for the Fed chairmanship, citing a potentially acrimonious confirmation vote in the Senate.

Now that administration officials term Ms. Yellen the front-runner, her leadership and management style are drawing more scrutiny. President Barack Obama is expected to announce his nominee in coming weeks.

People differ over Ms. Yellen's style and its effectiveness. Many senior Fed officials, including those who have opposed her on tough policy questions, say the 67-year-old Brooklyn, N.Y., native would be easy to work with if picked to lead the institution.

"She listens to all sides of a debate," said Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, who wants the Fed to end its $85 billion-a-month bond-buying program, which Ms. Yellen has strongly supported.

Some others who have worked with her behind the scenes disagree.

Dick Anderson, who served a brief stint as the chief operating officer of the Fed's Washington board, ending in December 2012, said, "Yellen's abrasive, intimidating style is probably more suited for a 'Mad Men' era as opposed to a modern office environment."

Mr. Anderson and Ms. Yellen clashed over a plan he proposed to cut spending by regional Fed banks, which she thought reached beyond his job description and resisted, according to people familiar with the matter.

Her style, Mr. Anderson said, sharply contrasted with Mr. Bernanke's style and wouldn't serve the Fed well.

A Fed spokesperson declined to comment on the matter.

A harder-driving style by the Fed chief, if Ms. Yellen adopts one, could push the central bank toward more decisive action, but also could make an already fractious institution even more so.

The process for making interest-rate decisions has been unruly at times for Mr. Bernanke. The 12 regional Fed bank presidents are vocal and often have sharply divergent views; his six fellow Fed board governors are quieter publicly, but their strong private views can have a big influence on decisions. He has worked patiently behind the scenes at times to forge policy compromises.

Ms. Yellen has pushed the Fed to use low-interest-rate policies to spur faster economic growth and bring down unemployment, but some other officials doubt the policies work and worry they will have negative unintended consequences such as higher inflation. That disagreement hangs over current decisions about whether to start pulling back the bond-buying program.

If she becomes the Fed's leader, Ms. Yellen would be challenged to balance the demands of maintaining the institution's collegiality against her own drive to move the place toward her sometimes strongly held beliefs, including her support for easy-money programs.

In the process, both insiders and outsiders would be watching to see if she attempts to impose more discipline on the 18 other policy makers, some of whom publicly air their divergent views.

"Speaking with fewer voices is quite desirable," said Alan Blinder, a Princeton University professor and former Fed vice chairman. "The question is, can anyone accomplish it? I'm not sure anyone can at this point. But Janet Yellen, who has watched the [Fed] from every vantage point, probably has the best shot at it."

Every Fed leader brings to the job a different style. Alan Greenspan's quiet authority was rarely challenged during his 18-year rule. His predecessor, Paul Volcker, clashed with governors appointed by President Ronald Reagan.

Ms. Yellen has had tense relations at times with Fed Governor Daniel Tarullo, the Fed's point person on bank regulatory issues, according to people who know them. But Ms. Yellen seemed to signal they were on common ground in a speech in San Diego earlier this year when she endorsed his views on regulation.

Ms. Yellen and Mr. Tarullo don't have disagreements on any substantive issues, said a person familiar with their relationship.

"She is very much a consensus builder," said San Francisco Fed President John Williams, a Yellen fan who served as the San Francisco Fed bank's head of research when she was bank president, speaking in an interview in April.

As evidence, Mr. Williams pointed to an important but little-noticed "statement of objectives" that Ms. Yellen helped the Fed craft nearly two years ago. It established a 2% inflation target and a framework for the central bank to think about attaining its other goal of low unemployment.

The statement, which shapes many of the Fed's decisions, was hotly debated for months with many differing opinions, but a Fed committee Ms. Yellen ran completed it despite disagreements about what it should say.

Still, Ms. Yellen has been a polarizing figure among some Fed staff members in Washington, according to several current and former staff members. An armada of more than 300 Fed staff economists plays a central role in examining the banking system, analyzing the economy and formulating policies.

Ms. Yellen led reviews of the Fed's research divisions after becoming vice chairwoman. In the process, several people said, Ms. Yellen ruffled feathers in the Fed's important monetary-affairs group, which was exhausted and depleted by the financial crisis. This group does most of the ground work formulating the Fed's interest-rate decisions.

Yet some other Fed staff members described Ms. Yellen as an excellent collaborator, citing her intellect, organization and support for them and their work.

_-- Victoria McGran​e contributed to this article._

###

# Inflation Fears Cut Two Ways at the Fed

##  Inflation Fears Cut Two Ways at the Fed

_By Jon Hilsenrath_

_April 3, 2010_

The Federal Reserve's decisions to keep interest rates near zero and to flood the financial system with credit are sparking fears of an eventual outbreak of inflation.

But inside the Fed, an influential band of policy makers is fretting over the opposite: that the already-low rate of inflation is slowing further.

The presidents of the New York and San Francisco regional Fed banks, William Dudley and Janet Yellen, see the abating inflation rate as convincing evidence the economy still is burdened by excess capacity and needs to be sustained by the Fed.

Others, led by Philadelphia Fed President Charles Plosser, argue that current inflation measures are distorted by an epic decline in housing costs and could mask a buildup of inflationary pressures.

This intensifying internal Fed debate over the behavior of inflation comes as the central bank plots an exit from an unprecedented experiment in easy money. Its read on inflation will influence how quickly it moves to raise short-term interest rates--which impacts everything from mortgage rates to new business costs to stock performance--and drain huge sums it pumped into the financial system during the recession. Recent developments have given the inflation-rate-is-dropping camp an upper hand.

In 2008, overall consumer prices actually fell for the first time in half a century, but then rebounded as energy prices stabilized. Over the past 12 months, the consumer-price index has risen 2.1%. But measures of inflation that strip out volatile energy and food prices are decelerating. Excluding food and energy, consumer prices in February were 1.3% higher than a year earlier. That was the smallest 12-month increase in six years, and well below year-over-year increases of above 2% before the recession.

"When unemployment is so high, wages and incomes tend to rise slowly, and producers and retailers have a hard time raising prices," Ms. Yellen, who is expected to be President Barack Obama's nominee to become the Fed's vice chairman, said in a speech last week. "That's the situation we're in today, and, as a result, underlying inflation pressures are already very low and trending downward."

Mr. Dudley made similar comments in comments in Lexington, Va., last week. "The substantial amount of slack in productive capacity that exists today will likely only be absorbed gradually. Consequently, trend inflation, at least over the near term, should remain very low."

In this camp, one worry is that inflation-adjusted interest rates--also known as real interest rates--could rise even if the Fed sits on its hands. Such a rise would be a disincentive for businesses to invest in new projects and for consumers to spend.

This unintended increase in rates could put a brake on the economic recovery.

The opposing camp believes the combination of low rates and more than $1 trillion the Fed has pumped into the financial system is a formula for inflation down the road. "As the economy improves and as lending picks up, the longer-term challenge we face will not be worrying about inflation being too low," Mr. Plosser said in an interview. "The risk is really to the upside of inflation over the next two to three years."

This camp focuses less on the amount of slack in the economy--the high unemployment rate and the number of empty office buildings, shopping malls and idle factories--and more on the risk that consumers and businesses will anticipate inflation and act accordingly. At the Fed's mid-March meeting, Thomas Hoenig, president of the Kansas City Fed, argued for an increase in short-term interest rates "soon" to "lower the risks of...an increase in long-run inflation expectations."

Surveys and bond price movements suggest Americans expect inflation of around 2% year-in and year-out, and Fed officials believe this helps keep the inflation rate stable. A change in inflation expectations in either direction could become important in Fed deliberations.

Mr. Plosser also argues that the recent decline in the inflation rate is a mirage, greatly influenced by an unusual decline in housing costs, which are heavily weighted in many price indexes. Excluding the cost of shelter, consumer prices were up 3.4% from a year earlier in February, pushed up in part by energy prices.

Excluding food, energy and housing, they were up 2.6% from a year ago. "I want to be careful not to read too much into one measure of inflation that is very influenced by housing," Mr. Plosser said.

Researchers at the San Francisco and New York Fed are scheduled to release a retort to this argument Monday that shows that among 50 different categories of consumer spending--from computers to hotels to jewelry--inflation rates have slowed over the past 18 months from the earlier trend.

The Fed has said it would keep short-term rates low for an "extended period," a phrase which means at least several months--as long as inflation is subdued, inflation expectations are stable and the economy is slack.

A persistent slowing of the inflation rate could push rate increases further into the future, possibly into 2011. But if officials dismiss recent data or if the pace of price increases accelerates, the Fed may boost rates before year-end.

Traders in futures markets anticipate the Fed will raise its benchmark federal-funds rate--which it has been holding near zero since December 2008--to 0.5% by November.

A wide range of companies recently have noted difficulty in trying to raise prices. General Electric Co., for instance, in a conference call with analysts, said prices of locomotive engines were falling because of excess supply. Speedway Motorsports Inc., which operates Nascar racetracks and drag strips, said it would reduce ticket prices between 4% and 5% this year.

"We have started to see a glimpse of the economy stabilizing," said Marcus Smith, Speedway's president. But he said he still had to fight hard to keep his customers.

"We're doing everything we can to make sure our existing customers are very happy. If they'll extend [contracts] this year for multi years we're willing to give better pricing and better terms."

But last week's Institute for Supply Management survey of factory managers found a rising fraction of respondents report paying higher prices for materials. In March, 53% said they were paying more--especially companies using petroleum products, wood and primary metals.

Although the consumer-price index gets more public attention, the Fed prefers another measure--the personal consumption expenditures index.

Excluding food and energy, it is up 1.3% from a year ago, and the slowdown is intensifying: Over the past three months, it has risen at an annual pace of just 0.5%, a slowdown that has been noticed by Fed officials. The Fed's preferred level for this measure is between 1.5% to 2%.

###

# Fed Chief Choice Shapes Up as Race Between Summers, Yellen

##  Fed Chief Choice Shapes Up as Race Between Summers, Yellen

_By Jon Hilsenrath_

_July 25, 2013_

The race to become the next leader of the Federal Reserve looks increasingly like a contest between two economists: Lawrence Summers and Janet Yellen.

Mr. Summers is an Obama administration insider who was at President Barack Obama's side during the 2009 financial crisis and maintains close contacts with the president and his top economic advisers.

Because Mr. Summers is well-known in the White House, Mr. Obama might have a higher comfort level choosing him.

Ms. Yellen, a Fed insider, has worked closely with the current Fed chairman, Ben Bernanke, formulating easy-money policies during the past three years and was a player in the Fed monetary-policy decisions during the worst of the financial crisis.

Because she is well-known within in the Fed, the institution might have a higher comfort level if she is chosen.

For months, outsiders have seen Ms. Yellen, 66 years old, as the favorite to succeed Mr. Bernanke when his term ends in January. But in the past couple of weeks it has become clear that in Mr. Obama's White House, Mr. Summers, 58, is seen as a serious rival, based on comments from current and former administration officials.

Both are baby boomer, Ph.D. economists--Mr. Summers's degree is from Harvard University; Ms. Yellen's from Yale University--with liberal political leanings. Both worked in the Clinton administration, when the economy was booming and the U.S. was ascendant. Both are known for strong views that they aren't shy about advocating. And both would likely place a heavy weight on reducing still-high unemployment in an environment of low inflation.

As Mr. Obama weighs his decision in the weeks ahead, the final call will come down to how he weighs the pros and cons of different resumes, reputations and personalities.

Mr. Summers was at the U.S. Treasury in 1990s as the U.S. advised governments in Mexico, Asia and Russia in putting out financial fires. He ran Mr. Obama's National Economic Council in 2009 as the new president was devising plans to prop up weak banks and revive the economy. Unlike Ms. Yellen, he spent time outside of government and academia as an adviser to hedge fund D.E. Shaw alongside a tenure at Harvard University.

Mr. Obama has seen up close the important role that a Fed chairman plays in a global financial crisis, and he could turn to Mr. Summers if he sees him as a higher-profile and experienced crisis manager with some financial-market experience.

Mr. Summers has what could be a big advantage of knowing Mr. Obama and his top advisers, some of whom are Summers fans. Since leaving the Obama administration in late 2010, he has visited the White House on at least 13 days, according to visitor records, including four visits with Mr. Obama, most recently in December.

Ms. Yellen, who taught at the University of California at Berkeley, has spent much of her career inside the Fed. She was a member of the Fed board in Washington in the 1990s during the years when Alan Greenspan was chairman; president of the Federal Reserve Bank of San Francisco in the 2000s; and, since 2010, has been Mr. Bernanke's No. 2 in Washington. She met her husband, George Akerlof, a Nobel Prize-winning economist, when the two were working at the Fed in the 1970s.

Ms. Yellen is schooled in the Fed's unconventional policies that have been adopted in the wake of the financial crisis and recession. She is also familiar with the peculiar inner workings of the central bank, where decisions are made by a group of 12 regional Fed bank presidents and seven Washington-based board governors, but driven by a powerful chairman and Fed staff. Fed officials spend a lot of time thinking about reaching consensus on tough decisions. Division and discord in a central bank can unsettle financial markets.

That's especially true now, as the Fed considers how to manage an exit from its extraordinary monetary policies. The hint of a pullback from a $85 billion-a-month bond-buying program has pushed up long-term interest rates by nearly a percentage point and sent stocks seesawing in recent weeks.

If Mr. Obama wants an official who can manage the complex institution and a committee of strong-willed individuals through what could be a destabilizing transition, he could turn to Ms. Yellen.

Both have spots in their records that would draw tough scrutiny in confirmation hearings. Mr. Summers was an advocate of financial deregulation before the crisis and was forced out as president of Harvard in 2006 after making controversial comments about women. All that could hurt him with Mr. Obama's liberal base, and he would be more of a lightning rod for attacks in a confirmation hearing.

Ms. Yellen is a strong proponent the Fed's easy-money policies, which makes some in Washington and in financial markets question her resolve as an inflation fighter when the time comes for that.

In other areas where one candidate looks weak, the other looks strong, but appearances can be deceiving.

Mr. Summers has a high profile on the international stage, jetting around the world to give speeches and writing a newspaper column. Ms. Yellen is far less prominent, but has quietly built relationships with other central bankers and finance officials at international meetings in her three years as Mr. Bernanke's No. 2.

After Mr. Bernanke skipped a recent meeting of Group of 20 finance officials in Moscow, Taro Aso, Japan's finance minister, said Mr. Bernanke's absence, "wasn't a big deal. That's because Ms. Yellen was there. In fact, she was gibbering away. At the London G-7 meeting [in May], it was also Ms. Yellen who spoke."

Mr. Summers is seen by many as a "bull in a China shop" with a demanding style that might be a bad fit for the consensus-minded Fed. But he is well-aware of the critique. And while Ms. Yellen has a low-key public demeanor, she is described by some current and former Fed staffers as a demanding boss who advocates her views forcefully.

It's possible that another candidate could make Mr. Obama's short list. Others have been mentioned, including Mr. Obama's former Treasury Secretary, Timothy Geithner. Right now it appears to be turning into a close race between Ms. Yellen and Mr. Summers.

Write to Jon Hilsenrath at jon.hilsenrath@wsj.com and Damian Paletta at damian.paletta@wsj.com

Corrections & Amplifications Lawrence Summers earned his Ph.D. from Harvard University. An earlier version of this article incorrectly said it was earned at the Massachusetts Institute of Technology.

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# Summers Withdraws Name for Fed Chairmanship

##  Summers Withdraws Name for Fed Chairmanship

_By David Wessel_

_Sept. 16, 2013_

WASHINGTON-- Lawrence Summers pulled out of the contest to succeed Ben Bernanke as chairman of the Federal Reserve after weeks of public excoriation, forcing President Barack Obama to move further down the list of contenders to head the central bank.

One leading candidate is Janet Yellen, the Fed's current vice chairwoman, who has garnered substantial support among Democrats in Congress and among economists. But the public lobbying on her behalf appears to have annoyed the president, say administration insiders, and may lead him to look elsewhere.

Mr. Obama has said he interviewed Donald Kohn, a former Fed vice chairman who is now a senior fellow at the Brookings Institution. Administration insiders say Timothy Geithner, the former Treasury secretary, also is a possibility, though a person close to him reaffirmed Sunday night that he doesn't want the job. Dark-horse candidates include Stanley Fischer, an American citizen who recently stepped down as governor of the Bank of Israel, and Roger Ferguson, another former Fed vice chairman and now chief executive of TIAA-CREF, a not-for-profit financial-services company.

Mr. Summers, a former Treasury secretary who has been one of the president's top advisers, withdrew in a phone call with Mr. Obama Sunday morning. In a subsequent letter to Mr. Obama, he wrote: "I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interest of the Federal Reserve, the Administration or, ultimately, the interests of the nation's ongoing economic recovery."

Mr. Obama said in a statement Sunday that he accepted Mr. Summers's decision and described him as "a critical member of my team as we faced down the worst economic crisis since the Great Depression, and it was in no small part because of his expertise, wisdom, and leadership that we wrestled the economy back to growth."

J. Bradford DeLong, a Summers backer at the University of California, Berkeley, said the decision to pull his name is "not something Larry would have done were he really the guy his adversaries claim he is."

U.S. stock futures surged late Sunday after Mr. Summers withdrew his name, soothing investors who had expected him to quickly wind down the Fed's easy-money policies.

Mr. Summers, who was director of Mr. Obama's National Economic Council early in his presidency, was widely believed to be the president's first choice. But opposition from liberals and women's groups--and, importantly, from some Senate Banking Committee Democrats--had been mounting.

For them, Mr. Summers became a symbol--a caricature, his admirers say--of all the failures of financial deregulation that led to the 2008 financial crisis.

"He was very clearly the president's choice," a former top administration official said. "After all the problems they had with the base, a big confirmation battle looked like a bridge too far."

Mr. Obama kicked off speculation about the Fed job in an interview with Charlie Rose in June in which he said Mr. Bernanke "had stayed a lot longer than he wanted or he was supposed to." Mr. Bernanke's second four-year term as Fed chairman expires Jan. 31.

The very public disclosure of Mr. Bernanke's plans led to an unusually public debate over potential successors. In particular, critics seized on Mr. Summers's reputation for abrasiveness, his closeness to Wall Street and accusations that he was hostile to women. The last was damaging given that one of his rivals was Ms. Yellen, who would, if nominated and confirmed, be the Fed's first chairwoman.

"It's shocking in the sense that Summers was so widely considered to be a front-runner," said Jared Bernstein, a former economic adviser to Vice President Joe Biden. "I'm sure they were very carefully counting votes--including Republican votes--and just believed that they couldn't get Larry out of committee."

At least three Democrats on the committee had said they would vote against Mr. Summers, most recently centrist Democrat Jon Tester of Montana.

In late July, about one-third of the 54 Senate Democrats signed a letter to Mr. Obama urging him to pick Ms. Yellen; it didn't mention Mr. Summers, but it was viewed as a warning to the White House.

Mr. Obama angrily defended Mr. Summers at a closed-door meeting with lawmakers, but he did little to thaw views among many liberal and centrist lawmakers that Mr. Summers was too combative and too close to Wall Street.

Ms. Yellen has in the past few months avoided substantive public comments on the economy or monetary policy. During the Fed's annual gathering in Jackson Hole, Wyo., in August, she told several people she didn't expect to get the job.

Mr. Summers's decision comes at a moment of vulnerability for Mr. Obama. He was close to losing a vote in Congress to authorize military strikes against Syria until Russia offered a last-minute diplomatic solution.

The move also coincides with the fifth anniversary of the collapse of Lehman Brothers and the ensuing financial crisis. Mr. Obama has a series of economic events planned this week, including a Monday Rose Garden speech, an address Wednesday to the Business Roundtable and a meeting Thursday with his export council. On Friday, he will travel to a Ford Motor Co. assembly plant in Kansas City, Mo., to highlight the success of the government auto bailout.

Now, the week may be overshadowed by fallout of Mr. Summers's withdrawal. But Tom Daschle, the former Senate majority leader, said he saw a silver lining. The withdrawal, he said, "significantly clarifies the president's choices and enhances his ability to reach consensus in Congress."

_-- Damian Paletta, P​eter Nicholas and Jon Hilsenrath contributed to this article._

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# THE RECORD: A GOOD, NOT SPOTLESS, RECORD ON THE ECONOMY

# THE RECORD: A GOOD, NOT SPOTLESS, RECORD ON THE ECONOMY

###

# Federal Reserve 'Doves' Beat 'Hawks' in Economic Prognosticating

##  Federal Reserve 'Doves' Beat 'Hawks' in Economic Prognosticating

_By Jon Hilsenrath and Kristina Peterson_

_July 29, 2013_

As the U.S. emerged from recession in the summer of 2009, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, took a grim view of the economy's prospects.

A WSJ analysis of more than 700 economic predictions between 2009 and 2012 by Fed policymakers shows doves, particularly Janet Yellen, have been the most prescient, while inflation hawks lagged the pack. Jon Hilsenrath explains. Photo: AP.

"I expect the pace of the recovery will be frustratingly slow," she said in a San Francisco speech. A month later, addressing fears that money flooding into the economy from the Federal Reserve would stoke inflation, Ms. Yellen said not to worry in a speech to Idaho bankers: High unemployment and the weak economy would tamp wages and prices.

Others at the Fed spoke forcefully in the other direction. Unless the central bank reversed the easy money course, Philadelphia Fed President Charles Plosser warned in December 2009, "the inflation rate is likely to rise to levels that most would consider unacceptable."

Ms. Yellen was proved right.

Predicting the direction of the U.S. economy with precision is impossible. But the Fed must forecast growth, inflation and unemployment to guide its decisions on interest rates. Central bank miscalculations--when the Fed pushed interest rates too low or too high--have historically turned problems into catastrophes, fueling the Great Depression, for example, and the wealth-eroding inflation of the 1970s.

The Wall Street Journal examined more than 700 predictions made between 2009 and 2012 in speeches and congressional testimony by 14 Fed policy makers--and scored the predictions on growth, jobs and inflation.

The most accurate forecasts overall came from Ms. Yellen, now the Fed's vice chair. She was joined in the high scores by other Fed "doves," policy makers who wanted aggressively easy money policies to confront a weak U.S. economy and low inflation. Collectively, they supported Fed Chairmen Ben Bernanke's strategy to pump money into the U.S. economy.

The least accurate forecasts came from central bank "hawks," those who feared Fed policies would trigger rising inflation.

Examining such predictions is more than a parlor game. Fed forecasts are important now because the central bank is near a turning point that will have a substantial impact on the U.S. economy.

Fed officials are considering whether to scale back an $85-billion-a-month bond-buying program this year, a move that could pull stock prices down and send interest rates higher.

If the Fed believes growth and hiring will pick up--and inflation will rise to a more normal 2%--the central bank will start to pull back on the purchases.

But if forecasts are wrong--if the Fed overestimates the economy's strength and pulls back too soon, for example--then economic growth could falter, stalling an incipient housing recovery and fueling the jobless rate.

"We should be keeping track of these forecasts and having some accountability," said Mark Gertler, a New York University economist who reviewed the Journal analysis.

Of course, forecasting ability doesn't always translate into wise central bank leadership. Arthur Burns, who led the Fed during the high inflation of the 1970s, was known for his forecasting prowess.

But New York Fed President William Dudley said forecasting errors have had serious consequences. "We were consistently too optimistic about growth over the 2009-2012 period," he said in a May speech. "As a result, with the benefit of hindsight, we did not provide enough stimulus."

Richard Fisher, the Dallas Fed president and another high scorer, took a different view. He has said slow growth was evidence the Fed's easy money medicine wasn't working and the economy needed less of it.

The Fed issues a quarterly forecast based on the views of its 12 regional Fed bank presidents and seven Fed governors. Over the past four years, these forecasts included errors, mostly from overestimating the economy's strength. None of the Fed forecast reports indicate who said what.

To evaluate the performance of individual Fed officials, the Journal looked at texts of speeches and congressional testimony. Forward-looking comments about the economy were rated for accuracy.

The Journal gave a mark ranging from -1.0--far off the mark--to 1.0--nearly perfectly correct--for each comment and averaged the total. A final score of zero showed someone was wrong as often as correct.

The analysis was shared with the Fed policy makers. Five of the 19 policy makers weren't ranked because they hadn't been at the Fed long enough or hadn't spoken publicly enough about the economy.

Ms. Yellen and Mr. Dudley--both in Mr. Bernanke's inner circle--ranked first and second in the Journal analysis. Both predicted slow growth and low inflation over the past four years. Ms. Yellen had the highest overall score in the Journal's ranking, 0.52. Mr. Dudley scored 0.45.

The lowest scores were tallied by Mr. Plosser, -0.01; St. Louis Fed President James Bullard, 0.00; Richmond Fed President Jeffrey Lacker, 0.05, and Minneapolis Fed President Narayana Kocherlakota, 0.07.

Investors who closely follow every comment by Fed officials don't appear to distinguish policy makers by the accuracy of their economic forecasts.

Macroeconomic Advisers LLC, a research firm, determined Mr. Plosser, Mr. Bullard and Mr. Lacker consistently moved markets more than Ms. Yellen. Messrs. Plosser, Lacker and Bullard and Ms. Yellen declined to comment for this article.

Forecasts by Fed officials depend on their view of how the economy works. Ms. Yellen, for instance, places great weight on the role of economic slack--high unemployment or idle factories--in driving inflation. Lots of slack, she has argued, holds down inflation. On the other hand, prices are more likely to rise when there are few available workers and factories are operating near capacity in this view.

"With slack likely to persist for years, it seems likely that core inflation will move even lower," Ms. Yellen said in September 2009. Her views warrant scrutiny because she is a candidate to succeed Mr. Bernanke when his term ends in January.

Mr. Dudley did especially well forecasting growth. Some Fed officials believed the current recovery would behave like past recoveries and the economy would, for a while, grow faster than its long-term trend of 3.2%.

But in May 2010, Mr. Dudley returned to his alma mater, New College of Florida, with a grim counter argument during a commencement address.

"The recovery is not likely to be as robust as we would like for several reasons," he said, pointing to the fragile banking system and the debt weighing down many households. He declined to comment for this article.

Other Fed officials, including Mr. Bernanke consistently predicted that faster growth was just around the corner.

"Although the pace of recovery has slowed in recent months and is likely to continue to be fairly modest in the near term, the preconditions for a pickup in growth next year remain in place," Mr. Bernanke said in October 2010, just before launching a bond-buying program. Growth slowed the following year.

Mr. Bernanke finished in the middle of the pack in the Journal's analysis, in part because he often relayed the consensus of Fed officials. He declined to comment for this article.

Luck also played a role in forecasts. In 2011, for instance, the economy looked like it was moving to faster growth when a tsunami struck Japan, disrupting the global economy.

The Fed's hawks had some of the worst forecasters. Mr. Plosser overestimated growth, while Mr. Bullard, Mr. Lacker and Mr. Kocherlakota warned of looming inflation. Their forecasts were wrong almost as often as they were correct.

While Ms. Yellen focused on the impact of slack on inflation, some hawks focused on money. The late Milton Friedman, the Nobel Prize-winning University of Chicago economist, said inflation was always and everywhere a byproduct of monetary policy: Prices only shoot higher when a central bank pumps too much money into the economy.

Hawks worried the Fed's decision to pump trillions of dollars into the U.S. financial system after the crisis would result in fast-rising prices. They sometimes couched their worries as risks, rather than predictions. In 2009, for instance, Mr. Bullard warned that the Fed's bond-buying programs had created a "medium-term inflation risk."

"The hawks have been issuing warnings, but there has been no sign of the things they've been warning against," said Martin Eichenbaum, an economist at Northwestern University and a Fed dove.

Mr. Kocherlakota of the Minneapolis Fed changed his hawkish views in 2012. "Inflation is not coming in as hot as I expected," he said in an interview last year. "You have to learn from the data." He declined to comment for this article.

Mr. Bullard changed his focus at times. In 2010, and again more recently, he signaled concern about inflation getting too low. A St. Louis Fed spokeswoman said the Journal analysis failed to account for the role Mr. Bullard's warnings played in formulating policies that helped to prevent inflation from getting too high or too low.

Some of the Fed's best forecasts came from noneconomists, including Fed governor Elizabeth Duke and Atlanta Fed President Dennis Lockhart--former bankers--and Mr. Fisher, a former investment manager. Some of the Fed's most brilliant Ph.D.s, including Mr. Kocherlakota, generated the most subpar scores.

Economists generally rely on economic models based on past behavior. These models are used heavily by the staff at the Federal Reserve Board in Washington and at regional Fed banks. But the recession and the current recovery were unlike most past cycles.

"The models have been wrong," Mr. Bullard, one of the Fed's many Ph.D. economists, said in an interview with the Journal in November.

James Hamilton, an economist at the University of California at San Diego who also reviewed the Journal's analysis, warned against betting that the doves' recent winning streak would continue.

"This was a period of subpar GDP growth and low inflation," he said. "Whether these same individuals would also prove to be better forecasters during a period of strong GDP growth and rising inflation is difficult to determine on the basis of the last four years."

One reason the hawks have been wrong about inflation is that the money the Fed has pumped into the financial system has tended to sit at banks without being lent to customers.

Economists say it is possible inflation can still catch fire if banks lend more aggressively and money starts circulating more widely.

If that happens, Mr. Eichenbaum said, the hawks would be proven right and "everybody else is going to look real bad."

_-- Michael R. ​Crittenden contributed to this article._

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# Fed's Yellen Says Stance on Banks Hardened

##  Fed's Yellen Says Stance on Banks Hardened

_By Damian Paletta_

_August 12, 2013_

WASHINGTON-- Janet Yellen, a top contender to lead the Federal Reserve, has evolved--in her own words--from a slightly "docile" regional bank regulator into a proponent of hard and clear rules designed to make banks less risky.

The change was prompted by her six years as president of the Federal Reserve Bank of San Francisco during a torrid period in financial history. As part of that job, which she held through 2010, Ms. Yellen oversaw scores of banks, some of which failed as the housing market collapsed.

An examination of her record suggests she pre-emptively warned colleagues about problems in the real-estate market but didn't take aggressive action to address them. While some bankers overseen by Ms. Yellen describe her as a determined regulator, critics note that she had a front-row seat for some of the turbulence that sent the economy into a tailspin and could have done more to prevent rampant real-estate speculation.

"The San Francisco Fed district, which includes Nevada and Arizona, was ground zero for the housing crisis," said Mark Calabria, director of financial regulation studies at the libertarian Cato Institute. If Ms. Yellen is nominated to be Fed chairman, "I think she at least has to answer that."

Ms. Yellen's views on monetary policy, a primary responsibility for any Fed chairman, are well known. She emphasizes the human and economic toll of high unemployment, and has been an architect of the policy under current Chairman Ben Bernanke of printing money to buy long-term bonds with the aim of reducing long-term interest rates.

But her views and track record on banking policy have received less scrutiny. That contrasts with Lawrence Summers, the former Clinton Treasury secretary and adviser to President Barack Obama who is another top Fed chairman candidate.

Mr. Summers long has called for simple regulatory rules for things like lending and risk, but the system remained a regulatory patchwork for years, with different agencies vying for power. Ms. Yellen said disagreements among regulators allowed financial companies to exploit gaps in oversight. She also has criticized the landmark financial bill Mr. Summers helped push into law in 1999 that ended the separation of commercial banks and securities firms, rules that had been in place since the Great Depression.

Ms. Yellen, 66 years old, who is now the Fed's vice chairman, declined to comment through a spokeswoman.

When the Brooklyn, N.Y., native joined the San Francisco Fed as its president in 2004, she sounded alarms with Washington colleagues about banks' heavy concentration in risky construction and home-development loans. Her warnings fell flat, she would later recall, as regulators from multiple agencies bickered about how to craft new rules.

When regulators finally wrote guidelines in December 2006, Ms. Yellen said they were late, diluted and toothless. "You could take this, rip it up, and throw it in the garbage can," Ms. Yellen told the Financial Crisis Inquiry Commission, set up by Congress to investigate the crisis, according to a recording of her 2010 interview.

Despite these warnings, her own agency's examiners had a mixed record. The parent company of Countrywide Financial Corp. was regulated by the San Francisco Fed until 2005, when the firm reorganized in a way that shifted oversight to the Office of Thrift Supervision, a move many saw as a ploy to seek a lighter regulatory touch. Countrywide, then a leading mortgage lender, buckled when the housing market tanked and was acquired under duress by Bank of America Corp. BAC +0.06% in 2008. Bank of America declined to comment.

"I am not going to say that we saw in that institution all the dangers that were lurking there," Ms. Yellen told the FCIC, the crisis-inquiry body. "Did we have a thorough appreciation of the flaws in the securitization process, and so forth, and the way they could affect the financial system as the whole? No. But we certainly saw we had the largest mortgage lender in the United States."

Steven Gardner, chief executive of Pacific Premier Bank in Irvine, Calif., called the San Francisco Fed "very upfront" under Ms. Yellen. His bank had a high concentration of commercial real-estate loans and was under constant scrutiny. "We knew if things went sideways that they would have been on top of us," he said. His bank emerged from the crisis on solid footing.

On other occasions, Ms. Yellen's examiners could have done more to intervene, the Fed's inspector general has reported. The San Francisco Fed discovered a number of "corporate governance weaknesses and other significant deficiencies" at Bank of Whitman in Colfax, Wash., in 2005 but failed to adequately intervene until 2009, the inspector general said in a March 2013 report. The 20-branch bank was closed by state regulators in August 2011, in part due to weak commercial real-estate loans.

The inspector general in a September 2010 report said examiners also missed warning signs at Barnes Banking Co. of Utah, which loaded up on commercial real-estate loans. The 10-branch bank failed in January 2010.

Eighty banks failed in the western U.S. from 2008 through 2010, though due to the fragmented regulatory structure less than half were overseen by the San Francisco Fed.

Few if any regulators emerged from the wreckage of the crisis with clean records. Ms. Yellen, an economist who previously served on the Fed's board in Washington and in the Clinton White House, didn't have an extensive background in bank regulation, but made it a focus in San Francisco. She didn't anticipate, she told the FCIC, that the bursting of the housing bubble that arose in 2005 and 2006 would lead to the havoc in the financial markets.

Ms. Yellen also said she was hesitant to push her examiners to crack down harder on banks, concerned that she lacked the authority. One reason for her hesitance, she told the FCIC in 2010, was the Gramm-Leach-Bliley Act, the bill supported by Mr. Summers that permitted securities firms and commercial banks to unite. She said Fed officials saw the law as giving them oversight of bank holding companies, not subsidiaries that didn't collect deposits.

Ms. Yellen told the FCIC she didn't see it as her place to challenge Fed supervisory policy, saying she was "a little more docile than some of my colleagues who feel, 'the heck with Washington, we know better.'"

"As worried as we were, we never simply went into banks and said, 'We insist you've got to have a higher capital requirement,' " she told the FCIC. "Did we have the power to do that? I think we felt we did not."

One large bank overseen by the San Francisco Fed, Wells Fargo & Co., originated risky mortgages through such a division that didn't accept deposits. Wells Fargo in 2011 paid an $85 million fine to the Fed in response to allegations that certain employees falsified documents and steered borrowers toward costly loans, but the bank didn't admit wrongdoing. Wells's CEO, John Stumpf, said at the time the alleged actions "are not what we stand for."

She said the financial crisis led her to believe that regulators had too much discretion and that the regulatory system needed to be tightened. She described herself as a proponent of tougher capital rules for banks, forcing them to build up reserves during boom years so they would have a larger cushion during downturns.

"This experience has strongly inclined me toward tougher standards and built-in rules that will kick into effect automatically when things like this happen that make tightening up a less discretionary matter," she told the FCIC. She said that would bypass the "kind of process that I think we have had where it takes six different regulators...to negotiate in what I gather is an excruciating process over many years to do something that in the end is probably too little, too late."

###

# Records Show Fed Wavering in 2007

##  Records Show Fed Wavering in 2007

_By Jon Hilsenrath and Kristina Peterson_

_Jan. 18, 2013_

Federal Reserve officials in 2007 appeared to underestimate the sickly condition of U.S. financial markets before shifting to a state of growing alarm, according to 1,566 pages of newly released transcripts from the central bank's meetings that year.

The transcripts, made public by the central bank after a traditional five-year lag, provide the most complete view yet of decision-making inside the nation's central bank at the dawn of a historic crisis, and provide fresh insight into the thinking of several key players still on the economic scene.

During most of the year, Fed Chairman Ben Bernanke embraced only reluctantly the interventionist stance that has defined his stewardship of the central bank. In December 2007, he said he was "quite conflicted" about whether to cut interest rates sharply. At other times, he talked about wanting to avoid bailing out financial markets, institutions or people.

Janet Yellen, the Fed's No. 2 who is now a leading contender to succeed Mr. Bernanke when his term expires in January 2014, emerges as one of the Fed's more prescient voices. Early in the crisis, she became alarmed about the impact of housing-market stresses on the economy, and became a leading advocate for aggressive action.

Like many others, U.S. Treasury Secretary Timothy Geithner, who at the time was president of the Federal Reserve Bank of New York, appeared early on to underestimate the growing financial stress.

The Fed began 2007 holding short-term interest rates at 5.25% and hopeful that a housing downturn was running its course.

When the housing crunch persisted and created strains in financial markets, the Fed began to mobilize. By year-end, it had embarked on a dramatic campaign of cutting interest rates and kicked off the first of a series of unconventional programs to stabilize markets.

The whirlwind that hit the global economy in late 2008 outstripped even the direst forecasts in the transcripts. The new record provides ammunition for the Fed's critics--both those who say it was too slow to act and those who say it was too aggressive in intervening in financial markets.

Allan Meltzer, a fellow at Stanford University's Hoover Institution and Fed historian, said the Fed responded appropriately in 2007 but has since taken on risks, such as large-scale purchases of mortgage and Treasury bonds that will be hard to unwind. His analysis of Fed transcripts over the years has led him to conclude that officials usually focus too little on the long-run consequences of their policies.

Mr. Bernanke sometimes sought to stake out a middle ground as debate raged, and early on he appeared not to anticipate how bad things would become.

In January 2007, he said the "worst outcomes" for housing had become less likely. That May he said he saw "good fundamental reasons to think that growth will be moderate."

Around the middle of the year, Mr. Bernanke began recognizing that market strains threatened to move to the broader economy and financial system.

He expressed reservations along the way about how to respond.

In August 2007, he sought to cast market turmoil in an optimistic light. While there was a risk that a twin housing and credit squeeze could become "difficult to deal with," he said, he thought "the odds are that the market will stabilize."

A few days later, in an emergency meeting, he said: "My own feeling is that we should try to resist a rate cut until it is really very clear from economic data and other information that it is needed. I'd really prefer to avoid giving any impression of a bailout."

By December, the U.S. already had moved into recession, according to a subsequent declaration by the National Bureau of Economic Research. The Fed was considering a large, half-percentage-point reduction in its benchmark interest rate to soften the blow of growing financial dislocation.

Mr. Bernanke said he was sympathetic to an aggressive move, but he chose a modest path--a quarter-percentage-point reduction.

"You can tell that I am quite conflicted about it and I think there is a good chance that we may have to move further at subsequent meetings," he told his colleagues.

As the year progressed, Mr. Geithner, who is stepping down as Treasury Secretary on Jan. 25, became increasingly concerned about financial stresses and more vocal about addressing the problem forcefully. But early in the year he played down the risks.

In January 2007, he said the subprime-mortgage market, which would later emerge at the core of the crisis, was small as a share of the overall mortgage market--a commonly held view at the time.

In June 2007, he played down problems at two hedge funds controlled by investment bank Bear Stearns. The bank collapsed in early 2008, becoming the first major bailout of the crisis and one of the Fed's most controversial.

"Direct exposure of the counterparties to Bear Stearns is very, very small compared with other things," Mr. Geithner said. Along with Ms. Yellen, Mr. Geithner is a potential Bernanke successor.

Some Fed officials emerge from the transcripts in a better light than others. William Dudley, who ran the New York Fed's markets desk at the time and is now New York Fed president, said in January 2007 that he saw "some risk of a vicious cycle" spinning out of subprime-market problems.

Ms. Yellen, then president of the Federal Reserve Bank of San Francisco, expressed growing alarm as the year progressed.

"I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector," she said in June 2007. "The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst."

By December, she was pushing the Fed to respond aggressively. She noted that the financial system's problems were happening in the "shadow banking system"--that is, not in traditional banks but rather in bond markets and derivatives markets where hedge funds, investment banks and others traded mortgages and other financial instruments. "This sector is all but shut for new business," she warned.

Mr. Bernanke settled on a quarter-percentage-point interest-rate cut at that meeting. Ms. Yellen wanted a larger, half-percentage-point reduction.

"At the time of our last meeting, I held out hope that the financial turmoil would gradually ebb and the economy might escape without serious damage. Subsequent developments have severely shaken that belief," she said in December.

The following month, the Fed slashed short-term interest rates by 1.25 percentage points as its alarm grew about the deteriorating economic backdrop.

By the end of 2008, the Fed pushed short-term interest rates near zero, where they remain, flooded markets with emergency credit and launched programs such as mortgage-bond buying, which have become hallmarks of its response to the crisis.

_-- Mich​ael S. Derby and Eric Morath contributed to this article._

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# THE POSITIONS: YELLEN PLANS TO CARRY ON BERNANKE'S APPROACH

#  THE POSITIONS: YELLEN PLANS TO CARRY ON BERNANKE'S APPROACH

###

# Yellen Stands by Fed Strategy

##  Yellen Stands by Fed Strategy

_By Jon Hilsenrath and Victoria McGrane_

_Nov. 14, 2013_

Janet Yellen, the White House's nominee to run the Federal Reserve, suggested she would stick to plans to wind down the central bank's $85 billion-a-month bond-buying program in the coming months if the economy perks up.

Fed officials are trying to decide "at each meeting" whether the moment is right to begin trimming the bond purchases, she told members of the Senate Banking Committee at a hearing on her nomination to succeed Chairman Ben Bernanke, whose term ends in January. "There is no set time," Ms. Yellen said.

The Fed's next meeting is Dec. 17-18.

With those and other carefully crafted comments on a variety of policy issues, Ms. Yellen signaled a plan for continuity at the Fed and passed her first leadership test without alienating two key audiences: the lawmakers quizzing her, and financial markets.

The Dow Jones Industrial Average finished the day up 54.59 points, or 0.35%, at 15876.22. Yields on 10-year Treasury notes edged lower to 2.702%.

"The prospective Fed chair gets an A for showing her depth of knowledge while at the same time showing an adept skill for communicating well under pressure while conveying the sense of continuity that markets expect during the transition ahead," Tony Crescenzi, a senior strategist at bond-fund manager Pimco, said after the hearing.

Republicans, though skeptical of the Fed's easy-money policies, treated the Democrat with almost uniform deference.

"That was a better answer than I got from Chairman Bernanke last July," Sen. Dean Heller (R., Nev.) said after Ms. Yellen responded to a question about gold-price movements by saying people like to hold gold when they become fearful of financial turbulence. "I asked [Mr. Bernanke] the same question, and he said that nobody really understands gold prices," Mr. Heller said.

The committee plans to vote on Ms. Yellen's nomination as soon as next week. She is expected to then win confirmation from the full Senate, though some Republicans are likely to vote against her, including Sen. David Vitter (R., La.), who said Thursday that he wouldn't support her.

Ms. Yellen, now the Fed's vice chairwoman, served as head of the Council of Economic Advisers under President Bill Clinton, president of the Federal Reserve Bank of San Francisco and as a professor at the University of California at Berkeley. If confirmed, she would be the Fed's first female chief.

Her husband, George Akerlof, a Nobel Prize-winning economist and also a Berkeley professor, sat behind her during the hearing. Mr. Akerlof is a visiting economist at the International Monetary Fund whom she drops off at work every morning on her way to the Fed. Mr. Akerlof, who is sometimes seen walking the IMF halls in hiking boots, showed up for the hearing in dress shoes.

Ms. Yellen dressed in a black suit and came armed with a handful of notes and a black satchel at her side. She spent much of her testimony, with hints of her Brooklyn accent, tackling senators' questions about bank capital, insurance regulation, asset bubbles, income inequality and other subjects.

Ms. Yellen, who is known at the Fed for her preparation, spent several weeks boning up for the hearing and met most members of the committee privately beforehand. Sen. Bob Corker (R., Tenn.) said he was impressed that her answers in public were the same as her answers behind closed doors.

One of the primary points of scrutiny at the hearing was the Fed's bond-buying program. The central bank began telegraphing in May that it could begin winding down the program before year-end. That caused stock and bond prices to sputter, and the Fed balked at moving in September.

When officials launched the initiative last year they said they would keep it going until they saw substantial improvement in the labor market. The officials have been hinting for several months that the economy may be getting to a point where it doesn't need the additional fuel of Fed money-printing.

Ms. Yellen stuck to that line of thinking without being definitive. The nominee said at the hearing that the decision about winding down the program depended on how the economy performs. "We have seen meaningful progress in the labor market," Ms. Yellen said. "What the [Fed] is looking for is signs that we will have growth that's strong enough to promote continued progress."

She also repeated the Fed's message that even after the bond program ends, it will keep short-term interest rates near zero for a long time because the bank doesn't want to remove its support too fast.

Critics have questioned the benefits and worry it could fuel higher inflation or financial-asset bubbles.

Ms. Yellen said the benefits still exceed the costs and dismissed worries of a stock bubble. "Stock prices have risen pretty robustly, but I think that if you look at traditional valuation measures...you would not see stock prices in territory that suggests bubblelike conditions," she said.

Not everyone was reassured. "I think the economy has gotten used to the sugar you've put out there. And I just worry you're on a sugar high," said Sen. Mike Johanns (R., Neb.), expressing concern about bubbles in stocks and real estate.

When asked about the problems the Fed's low interest-rate policies are causing for older Americans living on fixed-income portfolios and earning small returns, she sought to turn the question around.

"Savers wear a lot of different hats," she said. "They may be retirees, who were hoping to get part-time work in order to supplement their income. They may be people who have children who were out of work, and who were suffering because of that." She said Fed policies were helping those people by supporting economic growth and hiring.

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# Fed's Yellen Sets Course for Steady Bond-Buy Cuts

##  Fed's Yellen Sets Course for Steady Bond-Buy Cuts

_By Jon Hilsenrath and Victoria McGrane_

_Feb. 11, 2014_

The Federal Reserve will keep winding down one of its highest-profile easy-money programs unless the economy takes a serious turn for the worse, Janet Yellen said in her inaugural public appearance since becoming the central bank's first chairwoman.

In testimony before Congress, Federal Reserve Chairwoman Janet Yellen said she thinks the drop in labor-force participation is more structural than cyclical.

Some recent economic data have been soft, Ms. Yellen noted in her steady-as-she-goes comments before the House Financial Services Committee, but she doesn't want to overreact to that. She promised overall to press ahead with the policies of her predecessor as Fed chief, Ben Bernanke, delivering almost six hours of testimony (including multiple breaks) with little evidence of drama.

"Let me emphasize," she said, "I expect a great deal of continuity in the [Fed's] approach to monetary policy. I served on the committee as we formulated our current policy strategy and I strongly support that strategy."

Ms. Yellen was the Fed's vice chairwoman for more than three years before being sworn in last week as its new leader. From the No. 2 spot she pushed aggressively for the Fed to adopt easy-money policies, including the third round of bond buying launched at the end of 2012, to encourage borrowing, spending, investment and hiring. Her comments left little doubt that her plan--as was Mr. Bernanke's--is to tiptoe away from those policies only gradually as the economy improves.

The markets, having anticipated a steady stance, greeted Ms. Yellen's comments with approval. The Dow Jones Industrial Average rose 192.88 points, or 1.2%, at 15994.77. Yields on 10-year Treasury bonds rose 0.04 percentage point to 2.719%. The dollar inched up against the yen and British pound and was little changed against the euro.

"Markets got what they wanted from Yellen saying we'll get more of the same from the Fed," said Chris Gaffney, senior market strategist with EverBank Wealth Management.

Given the historic nature of the occasion--the first new Fed leader in eight years, the first female Fed chief ever--and the uneasiness of markets in recent weeks, Ms. Yellen's goal was likely to make no waves. If so, she succeeded. In two instances, she thanked lawmakers for calling her unexciting.

As the hearing wore on, business news channels cut away from her to cover other events. Wall Street analysts responded to her comments with notes declaring, "no real bomb-shells," "yawn... Yellen," and "Mini-Bernanke."

Lawmakers also praised her for her endurance. After the hearing, few Fed officials could remember a monetary-policy report to Congress lasting so long.

Rep. Denny Heck (D., Wash.) praised Ms. Yellen for possessing "an extraordinary amount of stamina" as the hearing finally drew to a close.

Ms. Yellen, who described herself at one point as a "sensible central banker," delivered her remarks in a matter-of-fact and somewhat monotonic style, at times reading from a thick black binder as she took questions from lawmakers. Her prepared testimony was notable in part for its brevity--a little over five pages compared with the typical eight to 10 pages of her predecessor.

"I've understood more of what you said today than I have probably the last two folks that were in front of us," said Shelley Moore Capito (R., W.Va.) referring to Mr. Bernanke and his predecessor Alan Greenspan.

Ms. Yellen did provide some important clues on the Fed's views about the economy, suggesting two months of disappointing employment reports won't sidetrack the Fed from its plan to wind down its bond-buying program.

"I was surprised that the jobs reports in December and January, the pace of job creation, was running under what I had anticipated. But we have to be very careful not to jump to conclusions in interpreting what those reports mean," Ms. Yellen said. Recent bad weather may have been a drag on economic activity, she noted.

Fed officials said in December that they would start scaling back their monthly bond purchases by $10 billion, to $75 billion, and said in January they would trim them again to $65 billion. Ms. Yellen said that if the economy continues to improve as expected, the Fed will keep reducing the pace of its bond purchases in measured steps.

Asked what would cause the Fed to alter its course, Ms. Yellen responded it would take a "noticeable change" in its outlook for growth, employment or inflation.

She also shed light on the Fed's internal debate over how much weight to put on the unemployment rate as it drops. In December 2012, officials said they wouldn't raise short-term interest rates from near zero until unemployment fell to 6.5%.

But as it has fallen--to 6.6% in January--officials have played down its significance. In their last two policy statements, officials said they would keep rates low "well past" the point when the rate reaches 6.5%.

Ms. Yellen amplified that point and said she is now looking beyond traditional measures of unemployment for cues on the economy, labor market and rate hikes.

"Those out of a job for more than six months continue to make up an unusually large fraction of the unemployed, and the number of people who are working part time but would prefer a full-time job remains very high," she said. "These observations underscore the importance of considering more than the unemployment rate when evaluating the condition of the U.S. labor market."

_-- Kaitlyn Kiernan ​contributed to this article._

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# Yellen Is Obama's Choice as Fed Chief

##  Yellen Is Obama's Choice as Fed Chief

_By Jon Hilsenrath and Peter Nicholas_

_Oct. 9. 2013_

President Barack Obama will nominate Janet Yellen to run the Federal Reserve, calling on the central bank's second in command to become the world's most powerful economic policy maker after months of sometimes bitter debate about Chairman Ben Bernanke's successor.

Ms. Yellen's nomination, which the White House said would be announced Wednesday, would be subject to Senate confirmation amid squabbling between Democrats and Republicans over fiscal issues. The federal government has been partially shut since Oct. 1, after its spending authority expired. The U.S. Treasury estimates that by Oct. 17 it will be low on cash because a federal debt ceiling prevents it from borrowing more.

Ms. Yellen's nomination would mean the Fed is unlikely to make any unusual lurches in its easy-money policies in the near term.

If confirmed, Ms. Yellen, 67 years old, would become the first female Fed chief in its 100-year history. She would also be the first Democrat in the position since Paul Volcker left the Fed in 1987. The timetable for hearings and a vote is uncertain.

"She has a depth of experience that is second to none, and I have no doubt she will be an excellent Federal Reserve Chairman," Tim Johnson (D., S.D.) the chairman of the Senate Banking Committee, said in a statement. In July, roughly a third of the Senate Democratic caucus signed a letter urging Mr. Obama to nominate her.

Her most immediate challenge as Mr. Bernanke's successor would be the one he has struggled with the past few months: deciding when and how to wean the financial system off easy money without torpedoing a fragile economy.

With unemployment slowly receding, the Fed has been trying to prepare investors for its eventual exit from an $85 billion-a-month bond-buying program. Many investors thought it would take a first step toward winding down the program in September, but Mr. Bernanke decided to hold back amid signs of a soft job market and looming fiscal clashes.

The Fed still could make a move before Mr. Bernanke's term expires at the end of January. There are three policy meetings between now and then.

Ms. Yellen has been a proponent of the Fed's efforts to spur economic growth with near-zero short-term interest rates and experimental bond-buying programs and worked closely with Mr. Bernanke as he crafted his strategies.

With inflation running below its 2% target, the central bank can afford to keep the nation's credit spigots wide open to encourage economic growth and hiring, she has argued.

"There is the high cost that unemployed workers and their families are paying in this disappointingly slow recovery," she said in a speech in March. "At present I view the balance of risks as still calling for a highly accommodative monetary policy to support a stronger recovery and more-rapid growth in employment."

Even if the Fed takes a first step to reduce its bond-buying program on Mr. Bernanke's watch, Ms. Yellen, who would take over in February if confirmed in a timely manner, would need to lead decisions about the pace of winding down the program.

The stakes are high, particularly on the timing and mechanics of the Fed's plans. Mr. Bernanke's statements about pulling back this year on the bond-buying program, sometimes called quantitative easing, or QE, pushed up borrowing rates on government debt, mortgages and other loans--undermining efforts to keep them low.

Global markets started reeling in May when Mr. Bernanke first made comments about the pullback on bond buying. But soft U.S. economic data caused Fed officials in September to continue their bond-buying program unchanged, causing investors to cheer. Markets have been on edge in recent weeks during the fiscal showdown in Washington but could be relieved by Ms. Yellen's nomination.

"The markets should like the continuity she represents and she is a familiar, well-understood voice when it comes to monetary policy," said Michael Feroli, economist with J.P. Morgan Chase & Co.

Fed officials face unresolved questions about how well their unconventional policies are working. The Fed's own research suggests the bond-buying programs have had at best modest effects on economic growth and hiring.

Mr. Bernanke has argued that the benefits outweigh the costs. A minority of Fed officials oppose the programs, saying they have done too little to help the economy and risk fueling higher inflation and financial bubbles. Some officials support the programs but want to limit their growth, worrying that as the Fed's securities holdings grow, the program's risks rise.

Based on her record, Ms. Yellen appears likely to proceed cautiously about removing the programs. But she would lead a divided committee of 19 policy makers, a number of whom doubt whether the bond-buying program is doing much good and worry that the Fed portfolio of $3.5 trillion in Treasury and mortgage securities is getting dangerously large.

The Fed also has sought to boost the economy by holding short-term interest rates to near zero and pledging to keep them there until the jobless rate, which was 7.3% in August, falls to 6.5% or lower. Most Fed officials don't expect to move short-term rates until 2015.

Mr. Obama's decision to put Ms. Yellen in the job assures the Fed will push forward with this plan to keep rates low well into the future. In speeches in 2012, she presented Fed staff research which suggested rates should stay near zero as late as 2016.

Mr. Obama set off months of public and often unflattering debate about potential successors after indicating in June that Mr. Bernanke wouldn't sit for a third term.

The president appeared to favor Lawrence Summers, his economic adviser in 2008 and 2009 and a former U.S. Treasury secretary. Some Senate Democrats, unhappy about Mr. Summers's record on financial regulation and disparaging comments he made about women while president of Harvard University in 2005, resisted his nomination. Mr. Summers withdrew from the running in mid-September.

Ms. Yellen's nomination could face challenges from Senate Republicans, who are likely to question her resolve to contain inflation and her support for the Fed's easy-money policies. She could also be pressed on whether she did enough as a bank regulator before the 2008 financial crisis to prevent the housing bubble and its fallout.

"I voted against Vice Chairman Yellen's original nomination to the Fed in 2010 because of her dovish views on monetary policy," Sen. Bob Corker (R., Tenn.), a member of the Senate Banking Committee, said in a statement. "I am not aware of anything that demonstrates her views have changed."

To get her way at the Fed, Ms. Yellen will need to manage the Fed's complex human dynamics as delicately as the levers of the nation's money.

Mr. Bernanke created a more consensus-oriented Federal Open Market Committee--the Fed's decision-making body--after more than a decade of dominance by his predecessor, Alan Greenspan.

The presidents of the Fed's 12 independent regional banks--based in places such as Kansas City, Philadelphia and Chicago--grew accustomed to speaking out more forcefully in public and in closed-door meetings about their views. The Fed's Washington-based governors have also been an important force for restraint on its programs in recent months.

Mr. Bernanke sometimes struggled to keep officials in agreement with his policies and to shape a coherent message when so many voices were speaking. Ms. Yellen, who has positioned herself in the camp of easy-money advocates at the Fed, could find it hard to corral others with opposing views.

Ms. Yellen, who earned her Ph.D. in economics at Yale University in 1971, has been the Fed's vice chairwoman since 2010. Before assuming that role, she held posts as president of the Federal Reserve Bank of San Francisco, as a Fed governor, and as chairwoman of the Council of Economic Advisers under President Bill Clinton. In addition, she spent many years as a professor at the University of California at Berkeley.

The Fed nomination also comes amid turnover in the central bank's Washington ranks. A seat on its seven-member board is vacant and another, currently held by governor Sarah Bloom Raskin, who has been nominated for a Treasury Department post, is likely to open soon. More seats could open next year. Fed governor Jerome Powell's term ends in January. Governor Jeremy Stein risks losing his Harvard tenure if he doesn't return next May. And if Ms. Yellen is confirmed as chairwoman, the job of vice chair will be left open as well. Sandra Pianalto, president of the Federal Reserve Bank of Cleveland has announced her intention to leave her post early next year.

_-- Kristina Peterson contributed to this article._

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# THE ECONOMY: FED CONFRONTING DOUBTS ON GROWTH, BUBBLES AND INFLATION

# THE ECONOMY: FED CONFRONTING DOUBTS ON GROWTH, BUBBLES AND INFLATION

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# Slack Attack: Fed Faces Test on Inflation

##  Slack Attack: Fed Faces Test on Inflation

_By Sara Murray and Jon Hilsenrath_

_Sept. 20, 2009_

BEND, Ore.--Tens of thousands of people who moved here in the past decade saw a booming real-estate market and plentiful jobs amid the mountains of Central Oregon. Now they see slack.

A year and a half of recession has left local manufacturer Bright Wood Corp. with too much capacity at its plants that make window and door components. Bright Wood has laid off nearly half of its work force, shut an 80,000-square-foot factory in Bend, and sold or stored its extra equipment.

Additional underutilized industrial space, housing and workers are apparent across town. More than 9,000 people have lost jobs since mid-2006. Some 29% of homes are vacant. "For Lease" signs hang on store windows near the town's main drag, Wall Street.

Similar slack--the unused portion of an economy's productive capacity--is evident across the U.S. Thousands of airplanes and hundreds of thousands of train cars sit unused, hotels report their highest vacancy rates in at least two decades, and millions of Americans are underemployed.

How much slack there is in the U.S. economy, how fast it can be taken up and the degree to which it matters will be central to the debate when Federal Reserve officials convene this week. The Fed isn't on the verge of raising interest rates or withdrawing the huge amounts of money it has pumped into the economy, but it is debating the signals to send about how quickly it will do so.

The interplay between slack and inflation is at the heart of that decision. Slack is important to their equation because, in theory, it should suppress wages and prices and keep inflation down. But if the Fed misreads the dimensions or significance of slack, it could unleash an unwelcome bout of rising prices.

The risk of inflation is significant. The federal government is running budget deficits on a scale last seen during World War II, while the Fed has pumped more than $800 billion into the banking system. Banks haven't been lending this money freely so far, but once they start, it could spur economic activity and send prices rising. One signpost of gathering inflationary fears is that the price of gold, often seen as a hedge against inflation, has soared by more than 40% since last October to more than $1,000 an ounce.

Inflation isn't a problem so far. Consumer prices have fallen 1.5% in the past 12 months, much of that because gasoline prices have collapsed. Excluding volatile food and energy prices, inflation is slowing: Prices have risen 1.4% in the past 12 months, by this measure, compared with a 2.5% rise over the previous 12 months.

Within the Fed, there's disagreement over slack. Most officials there believe it could take years for the economy to get revving fast enough to put strong upward pressure on wages and prices. Until that happens, inflation should remain under control, and possibly fall, allowing the Fed to keep interest rates low and to concentrate on restoring growth. But some Fed officials have been arguing for months that the central bank is putting too much weight on this argument and risks being behind the curve in combating inflation.

Dallas Stovall, Bright Wood's chief executive, sees both forces at work.

Sales at his company, based in nearby Madras, Ore., have fallen about 50% in the past two years. Its product prices have fallen roughly 30% in the past year. Its work force, once 1,000 to 1,200 strong, is below 600 after it closed the Bend factory at the end of 2008 and made other cuts. Now its factories are operating at about 40% capacity, despite a recent four- to five-month uptick in orders. Mr. Stovall has rehired some workers, temporarily, at lower pay.

He doesn't see things turning around soon--yet his worry is that the government's response to the financial crisis will unleash rising prices. "With the amount of debt and the amount of money we're printing, the only thing that can happen is inflation," he says. "It happens every time."

Economists have long debated what causes inflation. In the long run, if the Fed pumps too much money into the economy, it can drive prices higher if the economy takes off.

But many other factors play a role in the short term, including swings in commodity prices and the amount of fallow production capacity. It also depends on the expectations of individuals like Mr. Stovall: If businesses and workers expect more inflation, the theory goes, they start demanding wage and price increases and set off the inflation they fear.

Right now, the economy is swimming in spare capacity. Hotel occupancy rates were 56% on average this year through July, according to Smith Travel Research, the lowest since the firm started keeping records in 1987. Analysts at Credit Suisse estimate 2,535 Boeing and Airbus aircraft world-wide were in storage in July--14.2% of the world's fleet of these planes, a percentage that rivals the months after Sept. 11, 2001.

The Association of American Railroads counts 501,472 freight cars stuck in storage at the beginning of September, roughly one-third of the nation's total fleet. In housing, 18.7 million homes were vacant in the second quarter, up from 15.9 million four years ago, according to the Census Bureau. Vacancies in shopping malls and office buildings also are up.

In August, 14.9 million Americans were unemployed. Millions more were working part-time but wanted full-time work or said they would return to the labor force if there were jobs. All told, the Labor Department counts 26.3 million workers as underutilized, an increase of 13.2 million from two years ago.

Soaring unemployment gives workers less power to demand higher wages. The cost of wages and benefits for private-sector workers was up 1.5% in the second quarter from a year earlier, a sharp slowdown from increases of more than 3.5% seen much of this decade.

"The theory of slack affecting inflation--you are just seeing it in spades in wage growth, which has been plummeting," Janet Yellen, president of the Federal Reserve Bank of San Francisco, said in an interview in early September.

An improving economy is absorbing some of the slack. The Fed estimates factories were operating at 66.6% of their capacity in August, up from 66.1% in July, but far below the 79% average over the past quarter-century. Numbers of excess railcars and vacant homes have also inched down.

In all, the Fed's internal models of the economy show, the U.S. could be producing roughly $1.2 trillion more in goods and services than it is producing without straining its resources. When supply outstrips demand, prices tend to fall. Ms. Yellen figures inflation could fall from its already low levels, a view that prevails at the Fed.

But the sentiment isn't universal there. Federal Reserve Bank of St. Louis President James Bullard, a voting member of the Fed's policy-making Federal Open Market Committee, spoke out at the Fed's last meeting against putting too much weight on the economy's spare capacity as an inflation-damping force.

Economists, Mr. Bullard notes, have badly misread the degree and importance of slack in the economy in the past. In the 1970s, the Fed bet that high unemployment meant inflation would fall. Instead, it rose: The productivity of the nation's work force was slowing, resulting in a need for more workers that created unexpected inflationary pressure.

Then in the 1990s, when unemployment hit post-World War II lows, inflation didn't take off as some models suggested would happen. Many economists argued that the relationship between unemployment and inflation was dead.

"I don't want to bet the future of the country on these tenuous statistical relationships and on a theory that was really pretty badly discredited in past U.S. history," Mr. Bullard said in an early September interview.

Mr. Bullard argues that expectations of future inflation are a more important indicator of inflation's near-term direction. Consumers' inflation expectations, he notes, haven't fallen much. And, among some others at the Fed, he also argues that the conventional measures of slack are misleading. Some of the idle capacity won't be available--decayed vacant houses, obsolete factories--if demand revives, and thus may not help restrain rising prices, he says.

In Bend, even as the local economy begins to firm up, inflation still seems a remote possibility.

The town, a longtime haven for hikers and golfers in the summer and skiers in the winter, had just over 50,000 residents in 2000. Since then, a housing boom and thriving economy propelled the city to a population of more than 80,000.

Ashley Willard, a 25-year-old Bend resident, is a casualty of the town's slack labor market. Her temporary teaching position wasn't renewed because of budget cuts. If a part-time kindergarten position doesn't open up this year, as she hopes, Mrs. Willard plans to live off unemployment benefits, substitute teaching and her husband's income as the operations manager at a vacation-rental company.

Mrs. Willard says she no longer shops for clothes. She keeps an eye out for sales on staples like meat. "I'll buy groceries for the whole week so I don't run out and have an excuse to say, 'Oh, let's go out to eat,'" she says. On a recent shopping trip, her cart was stacked with discounted frozen meals.

In surrounding Deschutes County, the housing market has been flooded with foreclosed homes, another form of slack that can put downward pressure on prices and wages.

The number of default notices was more than 325% higher by mid-September of this year than in all of 2007. More than half of the homes that had been sold by mid-August were either short-sales--in which owners sold them for less than the value of their mortgages--or bank-owned, said Norma DuBois, a broker for Coldwell Banker Morris Real Estate in Bend. Rents are down, too, with homes intended for sale now competing on the rental market.

One wild card in the inflation outlook here is the behavior of banks.

Nationwide, banks have largely avoided lending the hundreds of billions of dollars the Fed has pumped into the system. Loans and leases on bank balance sheets are down 5% since the beginning of the year. Instead, these institutions are stocking up on safe Treasury bonds, or leaving extra money on deposit at the Fed.

At the Bank of the Cascades--Bend's largest locally based bank, with $2.4 billion in assets--total loans and leases are down 14% from a year ago. Its holdings of government securities and debt issued by government-backed lenders Fannie Mae and Freddie Mac are rising. In August, the Federal Deposit Insurance Corp. ordered Bank of the Cascades to improve its capital and liquidity, an indication the bank won't be flooding the local economy with cash anytime soon.

The bank didn't respond to requests for comment.

Around town, while the economy has pulled back from the edge, businesses are showing aversion to raising prices or spending more.

At downtown music shop Ranch Records, sales are down about 20% from last year . When the rent was set to go up 3% at the beginning of the year, the standard annual increase per their lease, store owner John Schroeder tried to get his landlord to negotiate. "He says he's pretty tight too, so he can't really budge," Mr. Schroeder said.

So Mr. Schroeder said he may take advantage of cheaper spaces just blocks away. Traditionally the retail vacancy rate here has hovered around 5% to 6%. It was 13.2% at the end of the second quarter.

Larry Snyder, the president and chief executive officer of High Desert Bank in Bend, says demand for loans is weak. "The dentist office that's thinking of expanding and adding another dental chair is holding off," he says.

From groceries to home prices to wages, costs haven't shown any hints of rising. And inflation? "I don't see it on the horizon whatsoever," Mr. Snyder says.

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# Markets Defy Fed's Bond-Buying Push

##  Markets Defy Fed's Bond-Buying Push

_By Jon Hilsenrath and Mark Whitehouse_

_Dec. 8, 2010_

The Federal Reserve's decision to spur the economy with a $600 billion round of bond buying was among the most controversial in its history.

Fed officials quarreled over whether to proceed. At worst, some members argued, such a move risked whipping inflation to dangerous levels.

Six weeks later, the bond program looks more like a water pistol than a cannon--and the reasons explain the immense and strange challenges of steering monetary policy in the aftermath of a financial crisis when short-term interest rates are already near zero.

The purchases of government bonds are meant to drive down long-term interest rates, which did happen in the lead-up to the Nov. 3 move. But since then, long-term rates are up sharply.

As Fed officials prepare to assess the program next Tuesday, they confront the latest counterweight to their interest-rate plan: the tax agreement between congressional Republicans and the White House that would extend Bush-era cuts and reduce payroll taxes. This has sent bond yields higher, not lower, by leading investors to expect more growth and inflation and to fret more about budget deficits.

The bond purchases were also expected to result in a weaker dollar, which proponents said would boost U.S. exports and which critics warned was inflationary. Confounding both camps, the dollar, after an initial fall, has risen.

The stock market has rallied, as Fed officials expected. Yet whether households are heartened by that is questionable.

Larry Stewart, a retired oil executive in Vienna, Va., says a 15% gain in his stock portfolio since late August, when the Fed broached the bond-buying idea, has given him little added confidence. Because of worries about his savings, Mr. Stewart says he is holding off on buying a new smart phone he wants and is cleaning his own house instead of paying a cleaner. "I still worry about having to dip into cash reserves to cover my living expenses," he said.

His concerns speak to broader obstacles standing in the way of the central bank. Its hope is that its purchase of Treasury notes and bonds will drive their prices up and send interest rates, which move in the opposite direction, downward--thus spurring both consumer spending and business investment.

Critics of the plan doubted it would work and warned it could fuel a speculative asset bubble in addition to inflation. But the early results suggest another outcome: The program might produce neither the burst in growth that officials so desperately want nor the inflation their critics so vociferously fear.

"The effect of the [bond buying] program itself is small enough that it is easily swamped by the bigger news from Europe over the last month as well as the political challenges that the program seems to have run up against." said James Hamilton, a professor at the University of California of San Diego.

In October, Mr. Hamilton estimated the program would keep long-term interest rates 0.2 percentage points lower than they would otherwise be. Today, he says the impact is probably a bit less than even that.

Fed officials have had modest expectations themselves. In what has become a common refrain, Vice Chairwoman Janet Yellen said in a mid-November interview, "I don't think this is a panacea."

On Tuesday, at their final policy meeting of the year, Fed officials are likely to leave the program unchanged. It calls for the Fed to buy $600 billion of bonds through next June, plus perhaps $300 billion more by reinvesting funds received as bonds from an earlier program mature.

The challenge the Fed faces is clear: The economy grew at an annualized rate of just 2.1% from the end of March through September, leaving unemployment stubbornly high.

Economic data have been looking better of late, with gains in consumer confidence, retail sales and some manufacturing indexes. To the extent that these improvements--or the stimulative result that could result from the new tax plan--are blocking the Fed's quest for lower rates, it's hard to complain.

A Federal Reserve Bank of Boston study estimates that through 2012 the bond purchases will result in 700,000 jobs that wouldn't otherwise be created, a big number, yet a fraction of the 8.3 million jobs wiped out in the recession. In a December Wall Street Journal survey of private economists, 42 of 52 called the estimate too optimistic.

The effort to spur spending and investment is constrained by fragile confidence and a hangover of the earlier debt boom.

At Ford Motor Co., "We've got to get debt down," Neil Schloss, the company's treasurer, said in an interview last week. Although Ford's car-finance unit tapped bond markets in September as interest rates fell--and although Ford on Thursday said it would invest $600 million in a Louisville plant--executives are averse to doing much borrowing because they want to win back an investment-grade credit rating. Ford's overall borrowing is down by $15 billion from a year ago.

While companies are grabbing cheap credit, many are investing and hiring outside the U.S. Chemical company Huntsman Corp. leapt at the chance to refinance $530 million of long-term debt in September and November. This reduced interest costs and pushed out repayment dates, helping Huntsman to invest in its business, according to its chief financial officer, Kimo Esplin. But the Texas company's biggest investment plans, which could result in roughly $400 million of spending in 2011, are for fast-growing economies in Asia. "Companies like Huntsman have easy access to capital markets, but they're taking that capital and they're funding growth outside the U.S.," Mr. Esplin said.

Around midyear, Fed Chairman Ben Bernanke began to lay the groundwork for bond purchases as he grew impatient with scant progress on growth and jobs, and with what appeared to be a deceleration of inflation. (Too much of a deceleration makes it harder to achieve low "real" interest rates--that is, rates adjusted for inflation--and could lead to outright deflation.)

In normal times, the Fed spurs the economy by moving short-term interest rates down, but it had already pushed those close to zero. Moving longer-term interest rates is a challenge, because they are determined by markets, which respond to a number of influences including expectations about future inflation and budget deficits.

The Fed first launched a bond-buying attack on long-term rates in the depths of the financial crisis. This first round of so-called quantitative easing ended in March. After Mr. Bernanke signaled in late August that a new round was coming, long-term rates began falling in anticipation. The average rate on prime 30-year mortgages stood at 4.36% the day before Mr. Bernanke sent the signal. It got as low as 4.17% in October.

John Donnelly was a beneficiary--and so was a car dealer. On Oct. 12, the retired sales manager in West Hartford, Conn., locked in a 4.25% rate on a new $240,000 mortgage loan. He used about $45,000 of it to buy a Mercedes for his wife. Though his new loan was bigger, his monthly payment hardly changed, thanks to the lower interest rate. "It's like free money," he said.

In Glastonbury, across the Connecticut River, medical-device sales manager Paul Popovich missed this window. He applied to refinance the mortgage on his home in mid-October, hoping to lop $150 off his $2,200 monthly payment. But rates started rising again before he could complete the process. "We were hoping for some relief, and it hasn't occurred yet," he said. Rates on 30-year mortgages now average 4.61%, their highest in six months, according to Freddie Mac.

Lowering rates can't put money in the pockets of many others because banks won't lend to them. About 11 million homeowners owe more on their mortgages than their homes are worth, making refinancing practically impossible.

Steve Ross, an apparel entrepreneur in Eastern Shores, Fla., has a $200,000 mortgage with an interest rate of 6.75%. He estimates the seaside condo he bought for $300,000 in 2006 is now worth $150,000--too little to serve as collateral for a new loan that could reduce his $2,000 a month in mortgage costs and condo fees. The Fed's stimulus "is not doing me any good," Mr. Ross said. "The bank isn't going to call me up and lower my interest rate."

About 70% of U.S. mortgage holders were paying at least one percentage point more than the going interest rate for 30-year fixed-rate mortgages in October, according to a Wall Street Journal analysis of data from research firm LPS Applied Analytics.

As for inflation, the economic cross winds are pulling it in different directions. Strong demand from overseas is pushing up the prices for many globally traded goods, including a white pigment used in paint called titanium dioxide. Huntsman raised titanium dioxide prices 17% earlier this year, and paint maker Sherwin-Williams Co. has raised paint prices.

When the Fed buys bonds from banks, it is in effect creating money, because it simply credits with cash the banks from which it buys the bonds. Flooding the financial system with more money could cause inflation.

The Fed doesn't see that as a risk because other forces are pushing inflation down, including banks' reluctance to lend and the overhang of unemployed workers, empty homes and unused plant capacity. Also, many domestic services aren't exposed to the buoyant global demand that is pushing Huntsman's titanium dioxide higher.

Danny Sayag, who runs two hair salons in Rockville, Md., is keeping the price of women's haircuts between $65 and $75. Rent at one of his two salons was reduced because of the soft real-estate market, and labor costs aren't rising because some other salons have closed and left stylists job hunting.

"It is not the right time to raise prices," Mr. Sayag said. "Why push the clients away from us at this kind of time?" Across the economy, the cost of a haircut in October was 0.4% higher than a year earlier, after averaging increases of over 3% for a decade, according to the Bureau of Labor Statistics.

Meanwhile, much of the money the Fed has created is sitting unutilized at banks, in saving accounts or in corporate coffers, reducing its potency as a source of either growth or inflation. U.S. nonfinancial businesses increased their liquid assets $1.932 trillion in the third quarter, a jump of $243 billion from a year earlier, according to the Fed. Banks' commercial and industrial loans outstanding in November were down 7.2% from a year ago; their holdings of low-risk Treasurys were up nearly 17%.

Mr. Sayag in Maryland says he has long been trying to get a loan from local Sandy Spring Bank to develop a plot of land to open a third hair salon, a beauty school and a supply store. He has been turned down, he says, because of the weak economy. "I don't blame the bank. It was the timing," he said. Since September 2008, Sandy Spring's portfolio of loans and leases has contracted to $2.1 billion from $2.4 billion, according to filings with the Federal Deposit Insurance Corp.

The bank's CEO, Daniel Schrider, declined to discuss individual clients, but said the bank's main goal in the past few years has been to clean up troubled construction and land-development loans. Though that process isn't over, he said, the outlook for lending is starting to look up. "We have transitioned...toward being much more interested in growing our business through quality credit opportunities," he said.

Mr. Sayag has restarted the process for a $2.5 million loan, and thinks he will get it this time because business is better and the cost of building is down. But, he added, "It's not going to happen overnight."

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# Fed Debates New Role: Bubble Fighter

##  Fed Debates New Role: Bubble Fighter

_By Jon Hilsenrath_

_Dec. 1, 2009_

Not so long ago, Federal Reserve officials were confident they knew what to do when they saw bubbles building in prices of stocks, houses or other assets: Nothing.

Now, as Fed Chairman Ben Bernanke faces a confirmation hearing Thursday on a second four-year term, he and others at the central bank are rethinking the hands-off approach they've followed over the past decade. On the heels of a burst housing-and-credit bubble, Mr. Bernanke now calls financial booms "perhaps the most difficult problem for monetary policy this decade."

With Asian property prices soaring and gold prices busting records almost daily, the debate comes at a critical time. Mr. Bernanke wants to use his powers as a bank regulator to stamp out bubbles, but the Senate Banking Committee, which will grill him later this week, is considering stripping the Fed of its regulatory power.

At the same time, pending legislation in the House could leave Mr. Bernanke running a less independent institution. The House Financial Services Committee has passed a measure that would subject the Fed's interest-rate decisions to scrutiny by the Government Accountability Office, an investigative arm of Congress. Mr. Bernanke and others at the Fed fear that with Congress looking over their shoulders, any decision they make about interest rates would be subjected to the winds of politics--making it harder to control inflation or financial bubbles.

Any changes would be months off at best, and the Fed might be successful in fending them off. In the meantime, officials are moving ahead to come up with plans to avoid another crisis.

Fed officials used to think there was little they could or should do to prevent bubbles from inflating. For one thing, identifying bubbles with any certainty was deemed to be too difficult. And even if they could be accurately pinpointed, pricking them might do more harm than good. Raising interest rates to stop a bubble, for instance, could slow growth in other parts of the economy that were otherwise healthy.

The Fed's main strategy instead was to mop up after a bubble burst with lower interest rates to cushion the blow to the economy and restart growth. That strategy was a key conclusion of Mr. Bernanke's writings on the subject of bubbles when he was a Princeton professor, and again when he first came to the Fed as a governor in 2002. It was an approach embraced by his predecessor Alan Greenspan.

Now, Fed officials admit the stance didn't work. They're groping for alternatives. Of the two methods to prevent bubbles--using regulations to protect the financial system from excess and changing monetary policy by raising interest rates--Mr. Bernanke falls on the side of greater regulation, an idea he has advocated in the past.

The best approach here if at all possible is to use supervisory and regulatory methods to restrain undue risk-taking and to make sure the system is resilient in case an asset price bubble bursts in the future," Mr. Bernanke said in answer to a question after a speech in New York last month.

Playing the interest-rate card, in contrast, is considered by many to be a more aggressive and risky move. On Tuesday, Philadelphia Fed President Charles Plosser said interest rates were "a very blunt instrument" to thwart a possible bubble. He said raising rates could "affect all other asset prices at the same time."

But some on the Fed's research staff are pushing senior officials to include interest rates in their plans--and some officials say they can no longer rule that out. Kevin Warsh, a Fed governor who spent seven years on Wall Street before moving to Washington in 2002, says he's keeping close track of commodities prices, the dollar and movements in credit markets. The Fed, he says, has to be open-minded in its search for solutions to bubbles, including whether interest rates should be used to squash them.

With unemployment high and conventional measures of inflation low, the Fed's top priority is to get the economy moving again. The Fed has said that means leaving interest rates low for at least several more months.

Yet the question of whether and how to tackle bubbles before they burst is becoming a growing concern amid fears of new bubbles developing in commodities markets and in emerging economies. Gold prices are up more than 50% in a year's time. China's Shanghai Composite stock index is up more than 75% this year. Stocks in Brazil are up even more. Oil prices have rebounded. They remain far below last year's peaks but a return to those highs could fuel inflation in goods and services more directly than tech stocks or housing did.

"This is a very dangerous period," says Frederic Mishkin, a Columbia University economist and former Fed governor. If a new bubble threatens to emerge and the Fed decides to fight it more aggressively, he says, it could damage an already weak economy. "You don't want to be fighting the last war," he says.

The debate extends far beyond the Fed. Researchers at the Bank for International Settlements, a Basel, Switzerland-based group that coordinates central-bank activities around the world, are pushing to address bubbles more aggressively. On a recent trip to Asia, the Fed's Mr. Warsh and San Francisco Fed President Janet Yellen got an earful from finance officials in China and Hong Kong, who worry that low U.S. interest rates are prompting investors to borrow in the U.S. and drive up asset prices in Asia.

The issue of rising asset prices--and what, if anything, to do about them--surfaced last month at the Fed's November meeting on the economy. Minutes released last week show officials worried about "the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period." One worry was "excessive risk-taking in financial markets."

Mr. Bernanke helped to launch his central-banking career while a Princeton University professor in 1999 with a paper he presented to Fed officials at their annual Jackson Hole, Wyo., conclave, in which he warned against trying to prick bubbles. Mr. Bernanke and his co-author, Mark Gertler, a New York University economist, argued that the Fed should focus on controlling inflation, not trying to manage the cycle of booms and busts.

Mr. Greenspan agreed, and let the tech-stock bubble run its course. The strategy looked like a winner. The 2001 recession was mild; the unemployment rate never exceeded 6.3%. Gross domestic product, the value of the nation's output, declined just 0.3% from its peak in the fourth quarter of 2000. As late as 2006, Fed officials were congratulating themselves and being applauded by many economists for the deft handling of that episode.

One of the few doubters was William Dudley, then chief economist at Goldman Sachs and now president of the New York Fed. He is one of the Fed's more outspoken proponents of preventing bubbles, and has said it's not as hard to spot them as many economists believe. "I can identify at least five bubbles that one could reasonably have identified in real time," including the tech boom, Mr. Dudley said in 2006 speech. He knew, he said, because he had speculated against three of them himself when he was at Goldman.

Fed officials are now debating the differences between bubbles as a way to understand them better and come up with the right solutions. Two economists influencing the debate are Tobias Adrian, a New York Fed researcher, and Hyun Shin, a Princeton professor. Their work shows that the credit bust was preceded by an explosion of short-term borrowing by U.S. securities dealers such as Lehman Brothers and Bear Stearns.

For instance, borrowing in the so-called repo market, where Wall Street firms put up securities as collateral for short-term loans, more than tripled to $1.6 trillion in 2008 from $500 billion in 2002. As the value of the securities rose, so did the value of the collateral and the firms' own net worth. That spurred firms to borrow even more in a self-feeding loop. When the value of the securities started to fall, the loop went into reverse and the economy tanked.

The lesson: The most dangerous part of a bubble may not be the rise in asset prices, but the level of debt that builds up at financial institutions in the process, fueling even higher prices. That means keeping these debt levels down might be one way to prevent busts.

The New York Fed's Mr. Dudley and others want to stop these kinds of borrowing spirals. The New York Fed, for example, is looking to increase its oversight of the repo market. It's considering whether to toughen collateral requirements on these loans so it's not as easy for firms to ramp up their borrowing in a boom.

Daniel Tarullo, the newest Fed governor, is organizing a new Washington-based swat team of analysts, supervisors, lawyers and accountants whom Fed officials dub the "quantitative surveillance" group. They are to troll through data on big financial firms looking for risks lurking in the system that officials will try to stamp out.

Bank regulators in the U.S., Europe and elsewhere are also considering rules that would require banks to have bigger capital cushions to discourage them from expanding too aggressively.

Mr. Adrian and Mr. Shin find low rates feed dangerous credit booms, and thus need to be a factor in Fed interest-rate calculations. Small additional increases in rates in 2005, they say, might have tamed the last bubble. "Interest-rate policy is affecting funding conditions of financial institutions and their ability to take on leverage," says Mr. Adrian. That, in turn, "has real effects on the economy."

His co-author, Mr. Shin, says "clumsy financial regulations" aren't enough to stop boom-bust cycles. "This would be like trying to erect a barrier against the incoming tide using wooden planks with big holes," he says. Using interest rates is the "most effective instrument" for regulating risk-taking by firms, he says in a new paper.

No one at the Fed has yet come out in favor of raising interest rates to stop the next bubble, but the idea is being discussed more seriously among Fed officials. Mr. Bernanke has been following Mr. Adrian's work closely.

One problem is that economists don't have models that prescribe how much interest rates should go up when asset prices or financial leverage run to excess, though several leading researchers, including Mr. Shin and Mr. Adrian, are starting to work in this area.

Donald Kohn, the Fed's vice chairman, was one of the strongest proponents of the old don't-pop-bubbles view. Today, he says, he has much less conviction about that strategy. Still, he worries that using higher interest rates to tame an asset boom would be like using a sledgehammer to drive a tack--it might stamp out the boom but it would do a lot of peripheral damage in the process.

"You raise interest rates [to fight a bubble] and you damp all kinds of capital spending and consumer durable spending," said Mr. Kohn in an interview.

Mr. Bernanke is leaving himself hedged. If he felt stamping out a bubble with higher rates would forestall a rise in inflation or stabilize the economy, "We'd have to think about that very seriously," he told the New York Economic Club recently. "We can never say never."

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# About This Book

##  About This Book

"Yellen and the Federal Reserve: A WSJ Briefing" was published in 2014 by The Wall Street Journal.

The foreword was written by Jon Hilsenrath. The art director was Manuel Velez. The editors were Nell Henderson and David Marino-Nachison.

For more coverage of central banks and the economy, visit www.wsj.com/economics. For questions about this or other e-Books from The Wall Street Journal, e-mail ebooks@wsj.com or visit www.wsj.com.

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