Yellen Leaving Fed With Full Employment, Increased Focus on Labor Market

Janet Yellen ends 14 years at the Federal Reserve this week, the last four as its first chairwoman, having guided the U.S. economy to its tightest labor market in nearly two decades by resisting calls to raise interest rates more rapidly.

The patient path she charted allowed the Fed to start reversing, without major turmoil, the aggressive stimulus measures she forcefully advocated during and after the 2008 financial crisis.

Ms. Yellen’s tenure as Fed leader, which ends Saturday, resembles a bookend to that of her predecessor, Ben Bernanke, who served as Fed chairman from 2006 to 2014, during the worst of the financial crisis and recent recession.

Mr. Bernanke, a scholar of the Great Depression, unleashed a whatever-it-takes counterassault after the bursting of the housing bubble in 2007 became far worse than officials anticipated.

Ms. Yellen, an expert in labor markets, urged greater attention to the costs of joblessness in steering the Fed to undo those emergency measures very slowly.

Her legacy is only partly written. The rest depends partly on whether the Fed can continue lifting rates gradually, but not so slowly that low borrowing costs fuel an asset bubble that ends in recession—as happened in 2001 and 2007.

Ms. Yellen leads her last policy meeting Tuesday and Wednesday, at which officials are likely to vote to hold their benchmark short-term rate steady in a range between 1.25% and 1.5%.

President Donald Trump last fall opted not to offer Ms. Yellen a second term as Fed leader. Instead he nominated Mr. Powell, a Fed governor since 2012 who has voted with Mr. Bernanke and Ms. Yellen at every opportunity.

Mr. Powell inherits a bright economic picture. Growth is steady. Stocks are hitting new highs. Hiring is robust. Unemployment is at a 17-year low.

Colleagues say Ms. Yellen will be remembered for reinforcing the Fed’s commitment to boosting employment. For decades, Congress has charged the Fed with maintaining stable prices and maximizing sustainable employment, but the former usually took precedence.

As vice chairwoman from 2010 to 2014, Ms. Yellen was among the Fed’s strongest advocates of unprecedented efforts—including holding short-term interest rates near zero and buying bonds to lower long-term rates—to boost hiring as well as growth.

Officials debated ramping up their asset purchases at a crucial Fed meeting in September 2012. According to a transcript, Ms. Yellen acknowledged her colleagues’ concerns but said they “pale in comparison to what I view as the potential economic and human costs of failing to reduce the unemployment rate as aggressively as we can.”

From the time she became Fed chairwoman in February 2014 through 2015, pressures built to raise rates. “I was anxious for us to move. There was anticipation” from markets, said Dallas Fed President Robert Kaplan, who joined the Fed in September 2015.

Ms. Yellen’s study of labor markets led her to conclude that although the overall unemployment rate was low, other measures suggested more slack in the labor market, such as part-time workers who wanted full-time jobs and people who had given up looking for work.

“Although that now seems almost axiomatic, it was a very contested proposition, certainly in 2014 and 2015,” said Daniel Tarullo, who served as Fed governor from 2009 until last April.

Another way Ms. Yellen convinced colleagues to move cautiously was to focus on the decline in the long-term neutral rate of interest, the level consistent with the economy operating at its full potential. A lower neutral rate meant officials wouldn’t have to raise rates as high as they have previously. As more colleagues agreed with her assessment, it became easier to justify her push to raise rates very gradually.

She also counseled against making the errors of central bankers who short-circuited expansions after financial shocks by prematurely removing stimulus, such as in Japan in the 1990s.

Colleagues deferred to Ms. Yellen, even when they weren’t fully on board, because they respected her expert reasoning, Mr. Tarullo said.

The Fed waited until December 2015 to start raising rates, and it has lifted them four more times since then. In October, it started shrinking its bond portfolio.

“One defining characteristic of her tenure is she made sure the Fed did not join the long list of central banks that screwed up by lifting off too soon,” said Bill Nelson, a former senior Fed official who left the central bank in 2016 to become chief economist at the Clearing House Association, a trade group.

Critics warned her go-slow approach would fuel roaring inflation or weaken the dollar, which didn’t happen. Others say lofty stock prices today show the bond-buying programs should have been dismantled earlier.

Ms. Yellen “did a very good job in terms of the targets” of low unemployment and inflation, said Martin Feldstein, a Harvard economist who advised President Ronald Reagan. “The problem is they didn’t start soon enough to recognize the increased risks to excessive asset prices.”

Insiders say Ms. Yellen also animated the Fed to focus more on how its policies would affect actual people, an approach drilled into her during her Ph.D. studies at Yale University by her mentor, the late economist James Tobin. Ms. Yellen encouraged greater attention on outcomes for subgroups, such as minorities, veterans or low-income Americans, and not just the population as a whole.

At a meeting with community activists last May, Ms. Yellen heard from Paola Angel Mendoza, a 44-year-old mother of two from Queens, N.Y., who explained how she had bounced between minimum-wage fast-food jobs with irregular schedules. Before she immigrated from Colombia, Ms. Mendoza had worked as an environmental inspector, a job that required a college degree.

By 2014, as the labor market firmed, a local college hired her as a research assistant—a desk job with fixed hours and medical benefits. She told Ms. Yellen, “I live a more dignified life because of the work that you have done.”

Ms. Yellen’s single term makes her record trickier to compare to predecessors. She is the first Fed leader in decades who didn’t face a recession or major crisis. She also never cut rates.

“The challenges were not as profound as what Bernanke faced, not as profound as what [Paul] Volcker faced,” said Lewis Alexander, chief U.S. economist at Nomura Securities. “Yellen’s challenges were more subtle and required subtle judgments.”