A Step in the Right Direction

So it seems likely that Janet Yellen will be the next Vice Chair of the Fed. I believe she is a great choice for several reasons. First, unlike Bernanke and other Fed apologists, she acknowledges U.S. monetary policy may have played a role in the housing boom:

[I]f a dangerous asset price bubble is detected and action to rein it in is warranted, is conventional monetary policy the best tool to use? Going forward, I am hopeful that capital standards and other tools of macroprudential supervision will be deployed to modulate destructive boom-bust cycles, thereby easing the burden on monetary policy. However, I now think that, in certain circumstances, the answer as to whether monetary policy should play a role may be a qualified yes. In the current episode, higher short-term interest rates probably would have restrained the demand for housing by raising mortgage interest rates, and this might have slowed the pace of house price increases. In addition, tighter monetary policy may be associated with reduced leverage and slower credit growth, especially in securitized markets. Thus, monetary policy that leans against bubble expansion may also enhance financial stability by slowing credit booms and lowering overall leverage.

Second, as noted above she is open to some form of macroprudential regulation. I have become convinced by Claudio Borio, William White and others at the BIS that this is an important idea given the current realities in the financial system. Third, Yellen acknowledges that the Fed is a monetary superpower. Just admitting this point means she is taking seriously the Fed's role in creating global liquidity conditions. Any candidate who brings such fresh thinking on these three issues to the Board of Governors would be a welcome change in my view. Yes, there are areas where I disagree with her--she thinks monetary policy is limited at the zero bound, I do not--but on balance she brings a perspective to the Fed that if followed makes its less likely the Fed will repeat the monetary policy mistakes it made in the early-to-mid 2000s. Making Janet Yellen the next Vice Chair is a step in the right direction for improving the Fed.