And the difficulties of her second brief were underscored by the fallout in financial markets last year after Fed Chairman Ben S. Bernanke merely suggested in May that the central bank might scale back its asset purchases.
Neither Bernanke, whose eight-year term ends Jan. 31, nor his predecessor, Alan Greenspan, had much success in dealing with bubbles. Greenspan presided over a stock market boom that went bust, pushing the economy into recession in 2001. He then watched as housing prices surged to unsustainable levels, peaking as Bernanke took over in 2006. Bernanke initially played down the economic impact of declining property prices, saying in March 2007 that the fallout was “likely to be contained.” He proved to be wrong as the U.S. at the end of that year entered its worst economic contraction since the Great Depression.
Artificial Bubbles
President Barack Obama spoke repeatedly last year about the need to avoid what he called “artificial bubbles.” He praised Yellen for “sounding the alarm early about the housing bubble” when he announced her nomination for the job of Fed chairman on Oct. 9. “She doesn’t have a crystal ball, but what she does have is a keen understanding about how markets and the economy work,” he said.
The Fed is devoting “a good deal of time and attention to monitoring asset prices in different sectors” to see if bubbles are forming, Yellen, currently Fed vice chairman, told the Senate Banking Committee on Nov. 14.
“By and large,” she said, “I don’t see evidence at this point in major sectors of asset-price misalignments, at least of a level that would threaten financial instability.”
The first test of the Fed’s loose monetary policy probably will come from a buildup in financial excess, rather than from an unwelcome rise in inflation, said Anil Kashyap, a professor at the University of Chicago Booth School of Business. Under the Fed’s favorite measure, inflation stood at 0.9 percent in November, less than half the central bank’s 2 percent target.
“They’ll have to worry about financial-market disruption more than they will about inflation,” said Kashyap, who was chosen by the American Economic Association to respond to Bernanke’s valedictory address to the group on Jan. 3.
Risk-Taking
The Fed’s zero-interest-rate policy is prompting investors to take greater risks with their money. The extra yield that buyers demand to own older, smaller junk bonds that trade infrequently shrank to an average 0.25 percentage point in the first half of this month from more than 1 percentage point a year ago, according to Barclays Plc data.