16

The Record Expansion of the 2010s

And the beat goes on.

—SONNY AND CHER, 1967

Economic events rarely align with the decadal calendar. The soaring “Sixties” really began with the Kennedy-Johnson tax cuts of 1964. The inflationary “Seventies” began in earnest with the first Organization of the Petroleum Exporting Countries shock in the fall of 1973. And so on. The record-shattering expansion of the 2010s is the exception that proves the rule. According to National Bureau of Economic Research dating, it began when the so-called Great Recession bottomed out in June 2009 and ended abruptly after February 2020 when the COVID-19 pandemic decimated economic activity all over the world. The expansion therefore encompassed the entire decade.

That said, the U.S. economy did not take off like a rocket in June 2009; the deep recession had caused far too much damage for that. As noted in the previous chapter, real GDP growth averaged just 3 percent over the last half of 2009 and a mere 2.6 percent over the four quarters of 2010. Net job gains did not appear until March 2010, and even then they were not sustained. What would eventually grow into a record-breaking run of consecutive job gains did not begin until October. All in all, the American people could be forgiven for thinking they were still living in a recession—as they did.

It turned out, however, that Americans of the day were experiencing the start of the longest business expansion in U.S. history, one that would likely have lasted even longer had the pandemic of 2020 not ended it abruptly. Over the forty-two quarters spanning 2009:3 through 2019:4, real GDP growth averaged 2.3 percent per annum; payroll employment rose for a record-setting 113 consecutive months, adding 21.3 million net new jobs in total; and the unemployment rate tracked down gradually but steadily from 9.9 percent to 3.5 percent, the lowest rate since 1969.

One important fact, however, seems to have been lost in most of the discussions since. The “secret” behind how the U.S. economy managed to bring the unemployment rate down so far while growing at just 2.3 percent per annum is no secret at all but rather a simple matter of arithmetic—and a profoundly negative piece of arithmetic at that: labor productivity performed miserably. After soaring in 2009 as frightened businesses reduced their labor hours more vigorously than they reduced output, productivity advanced at a sluggish 1 percent annual rate from the first quarter of 2010 through the last quarter of 2019, after which the pandemic turned the lights out.¹ For historical comparison, the previous worst productivity performance over a protracted period was the notorious—and still poorly understood—productivity slowdown of 1973–1995, when output per hour grew at a lackluster 1.5 percent annual rate. Thus, the U.S. economy experienced an employment boom without a GDP boom.

The 2012 Election

With the economy still weak in 2012, any talk of fiscal consolidation in the federal budget was clearly premature on economic grounds. But that was a presidential election year—the silly season, I like to call it—and antideficit sentiment was at or near its zenith. So, the 2012 campaign featured considerable discussion of fiscal “exit” strategies from the huge budget deficits of the day, despite the fact that the unemployment rate in 2012 averaged 8.1 percent.

President Obama’s opponent was Mitt Romney, the former governor of Massachusetts who had made a fortune in the private equity business. Republicans may have thought they could sell a successful businessman as just the person to fix an underperforming economy. After all, real GDP growth averaged barely over 1 percent during the politically sensitive second and third quarters of 2012, and the unemployment rate was still 7.7 percent on election day. Those are not the kinds of economic numbers an incumbent wishes to run on, and Romney argued that they should be blamed on Obama. Somewhat incongruously, by the way, he also ran against Obama’s signature legislative achievement—which Republicans derisively called “Obamacare”—even though it had been closely patterned on “Romneycare” in Massachusetts.

History records that the Republican sales pitch failed to work. Obama defeated Romney by about 4 percentage points in the popular vote and by a comfortable 332–206 margin in the electoral college. But Obama’s coattails were short, and the congressional win for the Democrats was modest. They added to their slim majority in the Senate but fell well short of the sixty votes needed to block Republican filibusters. In the House the Democrats picked up a few seats, but the Republicans hung onto their majority. President Obama therefore would still have to contend with stonewalling from Speaker John Boehner, egged on by the Tea Party faction in the House that was constantly pulling Boehner to the right. The configuration of the White House and Congress in January 2013 was thus tailor-made for partisan sniping and continued gridlock.

The Fiscal Cliff

Not long after the election, President Obama and Congress confronted what was ominously called “the fiscal cliff,” a term popularized by Federal Reserve Chair Ben Bernanke, who worried about it and sought to draw attention to it. The cliff was remarkably steep. Had the American economy fallen off, a recession very likely would have followed.

The fiscal cliff of 2012–2013 was man-made, though presumably accidentally. By sheer coincidence, various budget agreements reached in prior years had left both the Obama payroll tax cuts and the Bush income tax cuts set to expire in January 2013. In addition, long-term unemployment benefits were slated to be curtailed severely just then, and drastic formulaic spending cuts enacted as part of the budget agreement of August 2011 (but never intended to take effect) were also set to be triggered. Adding it all up, the nation was headed for a massive fiscal contraction—in the neighborhood of 4 percent of GDP—unless actions were taken to avert it.

Bernanke warned repeatedly that the Federal Reserve “cannot offset the full impact of the fiscal cliff. It’s just too big, given the tools that we have available and the limitations on our policy toolkit at this point” (Bernanke 2012b, 12). But partisan intransigence seemed poised to push the economy over the cliff nonetheless until a last-minute deal was reached on New Year’s Day 2013, technically one day after the U.S. government went over the cliff. (Luckily, January 1 is a holiday, so nothing happened.) The deal delayed sequestration by two months, extended some of the Bush tax cuts, let the payroll tax cut lapse but added some tax credits for low-income families, extended federal unemployment benefits, and more.

Washington’s fiscal battles were far from over, however. During the summer and fall of 2013, congressional Republicans sought to delay funding for President Obama’s signature policy achievement: the Affordable Care Act. Obama and congressional Democrats refused to accept the delay. The standoff produced another politically charged government shutdown when congressional spending authority expired on the last day of fiscal year 2013 (September 30, 2013). Raising the national debt ceiling—a hardy perennial—also became a political hot potato once again. Concerns actually arose that the U.S. government might default on its debt, not because the nation couldn’t afford to pay its bills but because Congress was mired in gridlock.

After sixteen arduous days, an agreement to end the shutdown was finally cobbled together in the Senate, passed by the House, and quickly signed by President Obama. The 2013 government shutdown was both long (as shutdowns go) and consequential. Some eight hundred thousand federal employees were furloughed, the national parks were closed, and a number of government services were severely disrupted. Much like the shutdowns of 1995 and 1996, shuttering substantial portions of the federal government did not redound to the political benefit of the Republican Party. Popular sentiment swung more toward Obama and the Democrats.

Theatrics aside—and there were plenty of them—fiscal policy was notably contractionary over the years 2011, 2012, and 2013, despite unemployment rates that averaged 8.9 percent, 8.1 percent, and 7.4 percent, respectively. As mentioned in the previous chapter, the Congressional Budget Office’s measure of the budget deficit, abstracting from automatic stabilizers, fell from a large 6.5 percent of GDP to just 1.9 percent of GDP over those twelve quarters, a policy shift of about 1.5 percent of GDP per year in an economy in which aggregate demand was still weak. Keynes was presumably rolling in his grave. Ben Bernanke, very much alive, was grimacing.

It was in 2013–2014 that Lawrence Summers (2014) began to revive an old theory originally due to Alvin Hansen (1939): secular stagnation, the notion that the U.S. economy faced a chronic (not just cyclical) shortage of aggregate demand. Curiously, Summers did not offer the recent years of contractionary fiscal policy as one of the possible (but easily reversible!) causes of that stagnation. Rather, he focused on the decline in the equilibrium rate of interest.

The Only Game in Town

Fiscal policy may have forsaken its role as a macroeconomic stabilizer. But true to its new designation as “the only game in town,” monetary policy did not. The Fed’s alphabet soup of special lending facilities was mostly wound down by 2011 for a simple reason: they were no longer needed. And having ruled out negative interest rates, the Fed could not push either the federal funds rate or the interest rate paid on reserves down any further. Ever since the end of 2008, the Fed had been relying on two main monetary policy instruments, each with many variants: quantitative easing (QE) and forward guidance. The Fed continued using those two tools through the end of Bernanke’s term and into Janet Yellen’s. (Those same tools, by the way, came roaring back in 2020.)

QE was discussed earlier. The twin ideas behind it were to shrink risk premiums in interest rates (e.g., by buying mortgage-backed securities instead of treasuries) and to shrink term premiums in interest rates (e.g., by buying long-term treasury securities instead of short-term treasuries). Three waves of “large-scale asset purchases,” as the Fed preferred to call them, were announced in November 2008 (QE1), November 2010 (QE2), and September 2012 (QE3). There was also Operation Twist, which came between QE2 and QE3. As mentioned in the previous chapter, the first episode of QE achieved the most dramatic results: the Fed succeeded in resurrecting the deceased market for mortgage-based securities (MBS). But the second round of QE was the most controversial politically, even though the Fed bought only treasuries.

The third QE episode marked a major departure for the Fed in that it did not prespecify a maximum value of treasuries to be purchased but instead left QE3 open-ended. In total, the Fed increased its balance sheet by $1,725 billion, most of which was agency MBS in QE1 and another $600 billion (all in treasuries) in QE2. In designing QE3, however, the Federal Open Market Committee (FOMC) decided to buy $40 billion per month in agency MBS and another $45 billion per month in longer-dated treasuries. No terminal date—and thus no cumulative amount—was announced.

Chair Bernanke gave the first hint of QE3 purchases coming to an end in congressional testimony on May 22, 2013. In answering a question, he observed that “if we see continued improvement and we have confidence that that’s going to be sustained then we could in the next few meetings … take a step down in our pace of purchases” (Reuters 2019). A mild statement, you might think. The Fed thought of it as indicating an intent to ease its foot off the gas pedal. Besides, “in the next few meetings” could mean months away, as it eventually did. Nonetheless, markets reacted strongly. Bond yields leaped; a month later, ten-year Treasury yields were about 50 basis points higher than they were before Bernanke’s statement. The stock market also reacted badly. The episode was quickly labeled the “taper tantrum.” Markets clearly did not relish the thought of their support being taken away—or even “tapered”—and let the Fed know. The central bank seemed surprised by the strength of the market reaction. It remembered this episode well when it started considering tapering again in 2021. It gave markets repeated advance notice, and this second taper went smoothly—no tantrum.

As it turned out, it was not until December 2013 that the Fed actually began to taper its QE3 asset purchases, ending them entirely in October 2014. By that time, the Fed had acquired just over $1.6 trillion in net new assets under QE3, making the grand total over the three QE episodes almost $4 trillion. Net of redemptions and maturing assets, the Fed balance sheet, which had started the crisis under $1 trillion, reached a peak of around $4.5 trillion in 2014.

Did these various QE programs achieve their goals? A naive look at Treasury rates would certainly suggest that they did; interest rates mostly fell during the QE period (figure 16.1). But, of course, interest rates had been falling for almost three decades prior to QE, and the downward trend during the QE period does not look especially sharp by eyeball. Econometric studies are far more sophisticated, and the consensus among them is that QE did work: interest rate spreads on MBS narrowed, and the Treasury yield curve flattened.²

FIGURE 16.1. Ten-year Treasury interest rates, 1981–2021.

Source: Board of Governors of the Federal Reserve System.

FIGURE 16.2. Spread between ten-year and three-month Treasury interest rates, 2008–2015.

Source: Board of Governors of the Federal Reserve System.

What is less frequently mentioned, however, is that the largest effects on interest rates appear to have come from QE1, the one QE episode that looks more like emergency relief from a financial crisis than “normal” monetary policy applied to bolster aggregate demand by shrinking risk or term premia (Krishnamurthy and Vissing-Jorgensen 2011). Figure 16.2 displays the spread between ten-year Treasury rates and three-month bill rates over the period 2008–2015. The sharp drop at the time of QE1 (November 2008) is evident. But there are no similarly dramatic drops at the time of QE2 (November 2010) or QE3 (September 2012).³

The FOMC’s other big “new” weapon was forward guidance, which the committee began to rely on more strongly, albeit in an ad hoc way, at its momentous December 2008 meeting. Its words at the time were “the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” “Exceptionally low” was easy enough to parse; it meant the just-established range of 0–25 basis points for the funds rate, the closest thing to zero that the Fed was willing to consider. The phrase “for some time” was more cryptic. Was that months? Years?⁴ In its March 2009 statement, the FOMC amended those words to “for an extended period,” which markets read (correctly) as “longer than we said in December 2008.” And that still-vague commitment to a near-zero funds rate remained intact until the August 2011 FOMC meeting.

At that point the FOMC, seeking to put more teeth into its forward guidance, began a series of experiments that it ultimately judged to be unsatisfactory. The first few attempts involved naming specific dates. The August 2011 FOMC statement observed that “the Committee currently anticipates that economic conditions … are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013” (FOMC 2011). Despite the clear escape clause provided by the words “at least,” that time frame was shockingly specific by the Fed’s historically tight-lipped standards. But as the calendar rolled into 2012, the “mid-2013” date started to look too close for comfort. Remember, the main idea behind forward guidance is to keep intermediate to long rates low. So, the FOMC changed its “zero” interest rate pledge again in January 2012, this time extending it to “at least through late 2014” (FOMC 2012a).

Several other major changes in Fed transparency were also made at the January 2012 FOMC meeting, including official adoption of numerical targets for inflation (2%) and the nonaccelerating inflation rate of unemployment (between 5.2% and 6% at the time) and the publication of the FOMCs first-ever “dot plot,” showing where members believed (or was it hoped?) the funds rate would go over the next several years. If there was any remaining doubt, this was now Ben Bernanke’s transparent Fed, not Alan Greenspan’s opaque Fed.⁵

Meanwhile, Charles Evans, president of the Federal Reserve Bank of Chicago, was arguing that forward guidance on interest rates should be tied to economic conditions, not to any particular date. His arguments made sense, and in December 2012 the FOMC adopted them with these words: “the Committee … currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored” (FOMC 2012b). It was a complex message. So, perhaps naturally, market participants focused on the numerical unemployment-rate target. The number 6.5 percent soon became a Holy Grail.

During 2013 the unemployment rate kept tracking downward, from 8 percent in January to 6.7 percent in December. With the FOMC still far from ready to raise rates and Ben Bernanke’s eight years at the helm drawing to a close, something had to give. But the December 2013 statement merely added that “the Committee now anticipates … that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent” (FOMC 2013). The phrase “well past the time” left traders wondering. Wasn’t U = 6.5 percent the magic number that would trigger rate hikes?

Passing the Baton: Monetary Policy under Janet Yellen

For markets craving continuity and also feeling a bit perplexed by the Fed’s clumsy messaging late in 2013, it would have been hard to imagine a better replacement for Ben Bernanke than Janet Yellen. President Obama’s choice shouted continuity, not change. For openers, no one could see much intellectual daylight between Bernanke and Yellen because there wasn’t much. Both were accomplished academic macroeconomists from elite universities (Princeton and the University of California, Berkeley, respectively.) Both were Keynesians, even though Bernanke was then a Republican and Yellen was a Democrat. More than that, when Yellen was named to replace Bernanke, she was serving under him as the Fed’s vice chair.

No Federal Reserve chair in history had ever served as many apprenticeships for the top spot as Janet Yellen. Her unprecedented Federal Reserve résumé began in August 1994,⁶ when President Bill Clinton appointed her to the Federal Reserve Board. About two and a half years later Clinton asked her to move to the White House to chair his Council of Economic Advisers, which she did for roughly another two and a half years before returning to her professorship at Berkeley. The Fed would soon beckon her again, however. In June 2004 Yellen was installed as president of the Federal Reserve Bank of San Francisco, and in October 2010 President Barack Obama elevated her to become vice chair of the Federal Reserve Board. Many Fed watchers speculated at the time that there must have been some understanding, though certainly no guarantee, that she would become the next chair when Bernanke’s term ended in January 2014.⁷ Otherwise, why would she leave the San Francisco bank?

By the time her turn came, Yellen had basically run the table. She had been a Fed governor, a Federal Reserve bank president, and vice chair of the Federal Reserve Board. She had worked shoulder-to-shoulder with Ben Bernanke for years. On top of all that, President Obama would surely relish the opportunity to appoint the first female head in the Fed’s history. Right? Well, yes. But not before a firestorm broke out.

It seems that Lawrence “Larry” Summers, the ex-secretary of the treasury, ex-president of Harvard, and ex-director of Obama’s National Economic Council, had thrown his large hat into the ring, where it landed loudly. Or maybe Obama threw it in for him.⁸ Summers wanted the Fed chairmanship for himself and, having served in the Obama administration for its first two years, looked well positioned to claim it. Virtually all of the top-ranking economic officials in the Obama administration in 2013 were either declared or covert Summers supporters. That group probably included Obama himself.

As soon as Summers’s name became public, however, a media firestorm broke out. Ghosts from his past came from everywhere to oppose him. Women’s groups remembered his unfortunate remarks about women being unable to compete with men at the top echelons of science and math. Labor unions and Democratic senators remembered his rather conservative views on financial issues. For example, lots of people remembered—and not fondly—his laissez-faire (or worse) attitudes toward regulating derivatives in 2000 and his lack of enthusiasm for using Troubled Assets Relief Program money to mitigate foreclosures in 2009–2010. Summers was looked upon as more of a friend to Wall Street than to Main Street.

All that said, Obama was nonetheless attracted by Summers’s obvious intelligence and deep experience. However, the president was also warned of a potentially nasty confirmation battle that could end in a rejection of the nomination by the Senate Banking Committee, where several members, led by Senator Jeff Merkley (D-OR), were hostile to Summers. So, Obama returned to the safety of nominating Yellen, who was confirmed easily by a 56–26 Senate vote on January 6, 2014, and took office on February 1, right on schedule.

It fell to Yellen to complete the monetary policy exit plan that Bernanke had often discussed but barely acted upon: reducing asset purchases under QE3 and modifying the Fed’s forward guidance. Forward guidance presented itself as the more immediate problem because of the muddle over 6.5 percent unemployment at the end of Bernanke’s term. The communication task looked difficult because the Fed was widely assumed to be poised to start raising rates once the unemployment rate reached that magic number, which was just slightly below where unemployment stood on March 2014 (6.7%). In fact, however, the FOMC was by no means ready.

Yellen quickly proved herself to be a master of the fine art of Fedspeak. The March 2014 FOMC statement, her first as chair, repeated verbatim Bernanke’s warning “that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends” (FOMC 2014), an ending that was still at some indeterminate time in the future. But then the statement noted that “with the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee’s guidance does not indicate any change in the Committee’s policy intentions as set forth in its recent statements.” Try figuring that one out. Updated guidance but no change in policy intentions? In fact, the financial markets accepted the Fed’s newest tortured prose with barely a hiccup. Chair Yellen had passed her first test with flying colors.

By the next FOMC meeting (April 2014) all traces of the 6.5 percent unemployment rate had vanished from the statement, never to appear again. QE3 asset purchases were also nearing their end. Yet the statement stuck with the previous forward guidance: “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends.” When would that be? The end of QE3 finally arrived in October, with the unemployment rate down to 5.7 percent. But the committee stuck to its view that rate hikes were not yet imminent. The dovish consensus on the FOMC was fraying, however. At the December 2104 meeting Yellen suffered three dissents, which is akin to a mass mutiny on the consensus-driven FOMC.

The central issue under debate at the time was familiar, especially to Yellen who had been a Fed governor in 1996–1997 when Greenspan debated—mostly with himself—how low the unemployment rate could go without causing inflation to erupt. Well after Yellen had left the Fed for the Clinton administration in 1997, the Greenspan Fed had allowed the unemployment rate to drift all the way down to 3.9 percent in the closing months of 2000, yet there never was an inflationary price to pay. Notice in panel (a) of figure 16.3 that it wasn’t just a matter of a long delay, as Milton Friedman might have suggested. The inflationary consequences of superlow unemployment never came. Would the 2010s look the same?

(a) Inflation and unemployment, 1995–2002

(b) Inflation and unemployment, 2014–2018

FIGURE 16.3. Inflation and unemployment, 1995–2002 and 2014–2018.

Source: Bureau of Labor Statistics.

The time to raise rates finally arrived at the December 16, 2015, meeting, when the FOMC decided unanimously to increase the target range by 25 basis points. It was no wonder they chose such a small increment. As the Fed’s first rate hike in seven years, it would be widely noticed and commented upon. By then the unemployment rate was down to 5.1 percent, a number low enough to frighten the FOMC’s inflation hawks and worry even some of its doves, a group that certainly included Chair Yellen. But despite widespread expectations that the Fed’s rate hike would be the first in a series, the 25 basis points in December 2015 proved to be a one-shot affair. The funds rate was bumped up that one time and then stayed put for a full year. No one could accuse the Yellen Fed of embarking on a crusade to vanquish some invisible inflationary dragon. Yellen and her colleagues wanted to see a live, fire-breathing enemy, which they did not.

In total, the Yellen Fed engineered just five rate hikes, each of 25 basis points, over her four years in the chair. Not much. It also began to shrink the huge balance sheet it had acquired, though again not by much. During that time, the FOMC watched the unemployment rate drift down from 6.6 percent to 4.1 percent and watched the core Consumer Price Index (CPI) inflation rate rise from 1.6 percent to 2.3 percent (see figure 16.3b).⁹ These were the “initial conditions” when President Donald Trump refused to reappoint Yellen (a Democrat) and handed the reins over to Jerome (“Jay”) Powell (a Republican) in February 2018.

The Yellen-to-Powell Handoff: Continuity Continues

Because Powell’s heroic actions in the 2020 pandemic made him a historic figure, it is easy to forget now that his chairmanship began as a smooth continuation of what markets had grown accustomed to seeing over the twelve Bernanke-Yellen years. At first, a few Fed watchers wondered about the fact that the patrician Powell was the first Fed chief since G. William Miller who did not have a PhD in economics. Greenspan, Bernanke, and Yellen had created a model. Going back through Volcker and Burns, an economist had led the Fed since Martin’s retirement except for Miller’s brief reign.

Serial Glass Ceiling Breaker

Janet Yellen is a distinguished economist who at this writing is serving as U.S. secretary of the treasury.¹⁰ Her remarkable career changed abruptly from successful academic to important policy maker one fateful day in 1994 during an airport stop en route from Berkeley to Yale. She was interrupted while changing planes by a call from the White House: Please reroute to Washington, DC, the caller said; the president wants to announce your nomination to the Federal Reserve Board today.

Yellen’s head was spinning when she arrived at the White House later that day. (I know; I met her there.) But no one could have predicted the amazing success story that would unfold over the coming years. Janet Yellen is the only person ever to lead all three key economic agencies: the Council of Economic Advisers, the Federal Reserve, and the U.S. Treasury. More remarkably, she was the first woman to chair the Federal Reserve Board (2014–2018) and is currently the first woman secretary of the treasury. For Yellen, there are no more glass ceilings left to break.

Janet Yellen was born and raised in Brooklyn, New York. She graduated as valedictorian of her high school class and went on to academic success at Brown University before enrolling in Yale’s PhD program. When she completed her Yale PhD in 1971, she was the only female to do so that year. She was already a pioneer.

After a few years of teaching at Harvard, Yellen joined the staff of the Federal Reserve Board in Washington, where one day in the cafeteria she met George Akerlof, a brilliant economic theorist who would later win a Nobel Prize. The two married in 1978, and in 1980 they both joined the faculty of the University of California, Berkeley. She was a Berkeley professor on that fateful day in 1994.

Yellen served for about two and a half years as a Fed governor. While there, she developed a reputation as a monetary policy dove, a skilled debater, and a person who always came assiduously prepared. In February 1997, President Clinton persuaded her to become his chair of the Council of Economic Advisers. After another two and a half years in the White House, she returned to Berkeley in 1999.

But Janet Yellen was hooked—on policy making in general, and on the Federal Reserve in particular. So, when the directors of the Federal Reserve Bank of San Francisco offered her the bank’s presidency (the first woman to hold that position, of course), she accepted with alacrity.

Yellen was so successful at the San Francisco Fed that President Obama nominated her to become vice chair of the Federal Reserve Board in 2010. In that post, she cemented her reputations for dovishness, competence, and hard work. She also helped Chair Ben Bernanke persuade the FOMC to adopt inflation targeting in 2012. After a fierce though mostly behind-the-scenes battle over Bernanke’s successor, she emerged as the Fed’s next leader.

Yellen tuned in another fine performance at the Fed’s helm, including extremely rapid job growth with no rise in inflation and a start on “normalizing” interest rates from their financial crisis lows. President Trump, who had criticized Yellen for being too political, reportedly considered reappointing her in 2018 but opted instead for Governor Jerome Powell, a Republican.

But Yellen’s illustrious career in public service was not yet over. President Joe Biden surprised many people—probably including Yellen—by tapping her to be his first secretary of the treasury in 2021. Among Yellen’s first jobs was helping to pass the huge pandemic relief bill known as the American Rescue Plan. Much more action followed, including a remarkable international tax agreement intended to reduce corporate tax shelters and sanctions on Russia when it invaded Ukraine.

They need not have been worried, however, and soon they were not. First of all, Powell proved to be a great Fed chair, but that’s a story for chapter 18. Second, he was reassuring and did indeed follow the Bernanke-Yellen script in his early years. Specifically, the Yellen Fed had raised interest rates three times in 2017, in each case by 25 basis points. The Powell Fed nearly replicated that performance in 2018, with four rate hikes of 25 basis points each. Markets thought that was about right. After all, as 2019 opened, inflation remained quiescent, the unemployment rate was 4 percent, and the federal funds rate range was only 2.25–2.5 percent. This did not look like tight money—except at 1600 Pennsylvania Avenue.

President Donald Trump raged against every rate hike, insulted the Fed, attacked Powell personally, and even threatened to remove him from office until some lawyer in the White House, I suppose, convinced him that he lacked the legal authority to do so.¹¹ (Readers of chapter 1 may recall that Lyndon Johnson received that same advice.) Long before the COVID-19 pandemic made Powell’s job substantively difficult, Trump made it politically difficult. But Powell soldiered on bravely, pointing out on many occasions that the Fed is an independent agency that does not take orders from the president; that the Fed chief can be removed from office only “for cause,” not because his policy decisions displease the president; and that he had every intention of serving out his four-year term. Support for Powell came from everywhere except the Oval Office.

Chapter Summary

Despite urgings from Fed Chair Ben Bernanke and many other economists, most of the fiscal policy changes over the years 2011, 2012, and 2013 reduced the budget deficit, leaving monetary policy as the only game in town when it came to supporting aggregate demand. In fact, the nation barely escaped falling off a 4 percent-of-GDP “fiscal cliff” on New Year’s Day 2013. The short-lived devotion to stimulative fiscal policy in 2008–2009 was clearly wobbling, to put it mildly.

Having lowered the federal funds rate to (its version of) zero in December 2008, the FOMC pursued easy money during the decade of the 2010s mainly by relying on several variants of QE and on dovish forward guidance about future rates. Federal Reserve talk thus changed in character. Communication had long been thought of as a supplementary tool that helped to explain the Fed’s interest rate policy and therefore reduce uncertainty and manage expectations. After 2009, it became an important monetary policy tool in its own right, possibly the Fed’s most important tool.

With fiscal and monetary policy pulling in opposite directions for much of the 2010s, the economy limped along. GDP grew slowly, but it grew. More salient politically, however, job growth did much better than GDP growth because productivity performance was so poor. The unemployment rate trailed downward year after year with only minor breaks.

In February 2014 President Obama passed the Fed’s reins from Ben Bernanke to Janet Yellen, who brought QE to a gradual halt and led the FOMC to promulgate its first rate hike in December 2015. Both were delicate transitions, deftly handled. But Yellen never raised rates very high before her term expired, nor did she put much of a dent in the Fed’s large balance sheet.

The Bernanke-to-Yellen handoff was about as smooth as a handoff could be, and so in its early years was the Yellen-to-Powell handoff. The federal funds rate kept edging up during Powell’s early years, and the Fed’s balance sheet was reduced a bit more. Just as Yellen could be said to be following the Bernanke playbook, Powell could be said to be following the Yellen playbook.

Until the roof caved in.

______________

1. There was a hint in the data that nonfarm labor productivity growth might have been returning to normal in 2019, when it averaged 2.4 percent at an annual rate. In 2020 and 2021, productivity (like much other data) bounced around wildly from quarter to quarter but also averaged a strong 2.4 percent per annum.

2. Many studies could be cited. See, for example, Krishnamurthy and Vissing-Jorgensen (2011) and Hamilton and Wu (2012).

3. It is possible, however, that some of the sharp drop in the spread in August 2012 came in anticipation of QE3.

4. It turned out to be seven years, but I’m pretty sure no member of the FOMC thought so at the time.

5. Bernanke also began to hold live press conferences after the April 2011 FOMC meeting. Having been a colleague of Greenspan’s on the Federal Reserve Board, I can testify that this degree of openness was inconceivable under Greenspan. Not even a transparency superhawk like me dared to suggest it.

6. I do not count here a stint as a Fed staff economist early in her career.

7. There are no term limits on Fed chairs. Bernanke could have requested a third term but did not.

8. In his memoir A Promised Land, Obama acknowledged what had long been rumored: Summers had been all but promised the Fed chairmanship years earlier as part of the deal that induced him to take the National Economic Council job in January 2009 (Obama 2020, 506–7).

9. To remind the reader, the Fed’s 2 percent inflation target was for core personal consumption expenditure inflation, not core CPI inflation. The former ran consistently below the latter throughout this period.

10. Truth-in-writing demands that I reveal that Janet Yellen has been a dear friend for more than twenty-five years.

11. At one point, Trump threatened to demote Powell to an ordinary Fed governor. Such an action, never anticipated by the Fed’s framers in 1913, would have precipitated a legal case. But it never happened.