On February 1st, Ben Bernanke will no longer be the Federal Reserve Chairman, and we will begin the reign of Janet Yellen, the newly appointed Federal Reserve Chairperson. Considering that the Fed just celebrated its 100th birthday and employs more Ph.D. economists than any other institution in the world, you’d think that the Fed would have monetary policy down pat. However, it doesn’t. Yellen herself admits that setting interest rates is often a shot in the dark. “I consider it essential, in making judgments about the stance of policy, to recognize at the outset the limits of our understanding regarding the dynamics of the economy and the transmission of monetary policy,” she said in a 2012 speech at NYU.
Yellen’s humble attitude will certainly well assist her as Chairperson, since just about every single issue she’ll deal with will be wrought with uncertainty. Is the U.S. economy stagnating, or threatening to overheat? How quickly should the Fed taper its purchases of long-term Treasury bonds and mortgage-backed securities? When should it begin to raise the federal funds rate, which has been nailed to the floor at zero to 0.25 percent since the end of 2008?
These dilemmas are generally looked at through a hawk-vs-dove monetary prism, but they are deeper and more interesting. The three big questions that Yellen will have to deal with answering will be thus: What is the most optimal amount of Fed control and oversight? How is the best way to manage economic and industry bubbles? What is the right proportion of mystery and transparency the Fed must maintain?