Opinion and Economic Analysis

HICKS: Yellen understands the Fed's conflicting roles

September 21, 2013

With Janet Yellen as the clear front runner for Federal Reserve chairwoman, rampant speculation regarding her approach to monetary policy fills blogs and editorials.

That is silly, of course. The Fed is a voting body with clear minutes of the many meetings she has attended as a voting member. Moreover, Yellen, like any real scholar, leaves a long and transparent trail of research on a broad range of topics. There is little reason to speculate about her approach.

Despite Yellen’s credentials and experience, both the extreme left and extreme right will continue to criticize the Fed

From the left, the Fed is often disparaged for being too close to the banking industry. Many on the left detest bankers as venomous villains of capitalism and enemies of the poor.

The barest accumulation of facts should defeat this viewpoint. The Federal Reserve is the biggest regulator of banks and maintains a broad think tank of some 600 economists who study banking and monetary policy. It could hardly be far removed from the banking sector and discharge its duties.

On the right, the Fed is distrusted as a tacit enabler of the growth of government.

We Hoosiers should be especially wary of such silliness. The Fed was born of the inability of state and federal governments to finance the Civil War and Spanish American War. Nowhere was the folly of a weak banking system more apparent than in Indiana, where Gov. Oliver Morton privately financed the Indiana regiments that marched to save the union in the summer of 1861. His is the sole statue to appear outside our Capitol Rotunda.

The Federal Reserve is a necessary institution. It is also an imperfect one.

The most salient concern about Fed actions is surely linked to its dual mandate of promoting full employment and maintaining low inflation. The fact is that these goals are necessarily in tension.

Among economists there is no real disagreement about the nature of the problem: There is a trade-off between unemployment and inflation. The problem is that the speed and size of this trade-off is uncertain, thus the policy criticism.

We know that if the Fed increases the supply of money in circulation, it artificially stimulates the economy, reducing unemployment but risking inflation.

We also know that this only works in the short run. Eventually, inflation or even the fear of inflation will slow the economy and reduce employment. A mistake could lead to a period of high unemployment and high inflation.

The Fed chair needs to understand the research on these issues. Janet Yellen does.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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