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December 2015
Isn't It Ironic? The Outlook for Federal
Reserve Policy
By Vincent R. Reinhart
Fed Chair Janet Yelien is widel viewed as a dovish central banker, but she is about to lead her institution into a
prolonged campaiqn of raising the policy interest rate. Starting nowv is u tactical decision on Yellen's part to achieve
her Ionger--run strategic aim. Hiking the funds rate, even as economic growth disappoints and iyflation remains
subdued. buys Yellen the credibility with her colleagues and market partic)ants to subsequently tighten slowin .
Thus, US monetary policy will remain accomrnodativejor a considerable period.
94 p ity the plight of Federal Reserve Chair Janet
Yellen, the late, great: John Makin advised ear-
lier this year (] akin 20 15).1 Over her entire policymak-
ing career, Yellen has routinely remi nded everyone that
the nation's central bank has a dual mandate of price
stability and maximum emprlmnient, sometimes to
the point of appearing to wear her heart on her sleeve
about the unemployed and underemployed, compared
to the flinty resolve of inflation--obsessed colleagues.
The ongoing dynamics of the UIS economy, however,
imply that the make-or-break decision for her repu-
tation in the long run will be about removing Federal
Reserve monetary policy accommodation. Because that
accommodation is so extraordinary---with the policy
rate currently pinned to zero and the Fed's balance
sheet amounting to about one-quarter of annual nomi-
nal gross domestic product (GDP) this process of pol-
icy tightening will be significant and protracted. AMnost
surely, it will begin at the policy-setting meeting on
December 15-16, 2015, wth a quarter-point increase
in the federal funds rate target, even though the growth
For a colection of John Makin's insights onthe economic outlook,
which will be sorely missed, see Americar Enterprise Institute John
Makin Economuc Outlook. wv,vw.aei.orgitagijo.hn--makin-econoniic-
outlook/.
performance of the US economy is lackluster and infla-
tion continues to run below the Fed's goal.
That Yellen rnay go down in central banking history as
The Great Tightener appears to pose more than a lit.-
tie irony, perhaps to the coming surprise and irritation
of Senate Democrats who signed a letter to the presi-
dent endorsing her Fed-chair candidacy il 2013. Yet,
the shift in policy does not reflect a transformation of
her beliefs, but rather their pursuit by different means.
Tightening now follows logically from Yellen's under-
standing of the economic outlook and the dynamics of
the Fed's policyrmaking group, the Federal Open Mar-
ket Committee (FOMC). Hiking the funds rate., even
as economic growth disappoints and inflation remains
subdued, buys Yellen the credibility with her colleagues
and market participants to subsequently tighten slowly.
That is, Yellen positions herself now as a conservative
central banker to ensure that she can be a compassion-
ate one later by allowing Fed policy to remain consider-
ably accommodative for a considerable time.
Understanding this dynamic requires working through
the likely outlook for the US economy, our place in
global finance, and the trade-offs involved with getting
a disputatious policy committee to agree on a plan for
AMERICAN ENTERPRISE INSTITUTE](ViewImageLocal?handle=hein.amenin/aeiabxz0001&div=1&collection=&method=preview&ext=.png&size=3)