Barring any shenanigans from the Senate, the new Biden administration will feature America’s first ever female Treasury secretary in 2021. It may not be Elizabeth Warren, but at least the nomination of Janet Yellen means that we shall break free—at least for a time—of the seemingly endless Wall Street/DC revolving door that has characterized recent appointments to this crucial position.
Yellen herself has extensive public policy experience, first as a governor of the Federal Reserve Boar from 1994 to 1997, then as the chair of the White House Council of Economic Advisers under President Bill Clinton from 1997 to 1999. More recently, she returned to the Fed under the Obama administration, where she broke another glass ceiling when she became its chair in 2014. In that sense, Biden’s nominee has a unique institutional understanding of the interrelationship between the Treasury and the nation’s central bank, which should vastly enhance policy coordination between the two at a time when it is desperately needed.
Still, applause for Yellen’s appointment comes with a few caveats. There is no question that the incoming Treasury secretary fully appreciates the gravity of the current crisis and the corresponding need to offer full fiscal support to avert a severe relapse in economic activity. At times, however, she has unnecessarily fretted about the size of the national debt, as in 2017 when she indicated that the $20 trillion figure “should keep people awake at night” and consequently raised interest rates before the economy had fully recovered from the 2008 crisis.
Yes, US national government debt today has reached its highest level relative to GDP since World War II, but nobody at that time focused on deficit reduction; they worried about winning the war. By the same token, what should keep Yellen “awake at night” today is the prospect of decades of economic stagnation (and yet more debt accumulation) if fiscal policy is insufficiently supportive of growth because of attempts to reduce the deficit prematurely before the economy reaches takeoff trajectory.
Likewise, at times in her accomplished career, Yellen has been disturbingly complacent regarding the underlying risks that the economy faced because of massive financial deregulation and poor regulatory supervision. As recently as 2017, she blithely expressed the view that there would be no new financial crisis “in our lifetimes.”
While the Dodd-Frank financial reforms were better than nothing, it has become increasingly evident that the legislation failed to remedy the economy’s underlying financial instability. Indeed, the very opacity of the Wall Street–created financial derivatives that are still allowed to exist (such as collateralized debt obligations) continue to make it easy to inflate asset values massively and evade proper regulatory oversight. Contrast Yellen’s attitude to that of some of her regulatory counterparts, such as Brooksley Born, who as head of the Commodity Futures Trading Commission (CFTC) in the 1990s presciently warned of the growing systemic risks in the economy, at a time when many (including Yellen herself back in 1996) remained oblivious to them.
It is true that today’s challenging economic environment was not triggered by a financial crisis per se. However, Covid-19 should not obscure the fact that our global financial system continues to be characterized by ongoing fraud epidemics of precisely the kind that drove the financial crisis in 2008 and beyond, and could well become evident again as second- and third-order impacts of the pandemic manifest themselves in the months ahead. If anybody should be aware of this, it is Janet Yellen, as her husband, Nobel Laureate economist George Akerlof, has written for decades about fraud and the corresponding opportunities for corporate looting in an environment characterized by lax financial regulation.
In fairness to Yellen, more recently she did show a willingness to drop the hammer on the big banks in a way that some of her predecessors eschewed. In her final major action as head of the Fed in 2018, for example, Yellen imposed serious sanctions against Wells Fargo for “widespread consumer abuses” (in contrast to most of Obama’s monetary and financial regulatory appointees, many of whom displayed a marked lack of enthusiasm for punishing Wall Street wrongdoing in the wake of the 2008 crisis).
As Treasury secretary, Yellen’s views on fiscal policy will be key. In this regard, the early omens are good: Two months ago, she warned that the economic recovery would be uneven and lackluster if Congress failed to offer additional fiscal support to fight unemployment and keep small businesses afloat. Of particular significance, Yellen specifically noted that a lack of aid to state and local governments could hamper economic recovery.
This is a crucial insight, because falling sales- and income-tax revenues are currently prompting US state and local governments to cut spending, compounding the widespread loss of jobs and incomes. Furthermore, as Yellen appreciates, it is the states, not the federal government, that will largely handle distribution of the vaccines and therefore will play a key role in mitigating the pandemic’s spread. So ongoing fiscal support to them remains essential from both an economic and a public health perspective.
Equally significant (and despite her previous role as head of the Fed), Yellen has recently accorded primacy to fiscal rather than monetary policy. Monetary policy, which largely operates by altering the cost of borrowing, is a more indirect—and therefore less effective—means of stimulating aggregate spending. The effects are variable because, while borrowers face lower costs, those who earn interest income (such as retirees) have less purchasing power because of lower interest income. Furthermore, in an economic environment characterized by pessimism about future returns on capital investment and a heightened risk of unemployment, corporations are unlikely to take on more debt to fund job-creating investment no matter how low the costs of borrowing might be. In such circumstances, it is largely the role of the Treasury, not the Federal Reserve, to step up via robust fiscal policy to directly address the deficiency of demand and investment. Time is of the essence here, given the long-term damage already sustained in the economy.
Fortunately, Yellen gets this. She recognizes the need to generate employment for tens of millions now out of work, using the fiscal powers of the Treasury to build the productive capacity for the economy (to avoid future inflationary constraints as and when GDP does recover to pre-Covid-19 levels). At the same time, as a former head of the US central bank, she is in a unique position to understand the institutional dynamics and capacities of the Fed, thereby ensuring ample policy coordination between the two institutions. Happily, she will derive significant support in this regard from the current Fed chairman, Jerome Powell, who has continued to agitate for additional fiscal policy support from Congress and the Treasury.
Furthermore, in contrast to Steve Mnuchin (or indeed, anybody in the Trump administration), Yellen understands that pandemic mitigation via a robust public health response is a necessary precondition for sustainable economic growth. The ongoing manic-depressive cycle of opening and locking down with economic gyrations to match is not a sustainable strategy to facilitate long-term recovery. So it is encouraging to see her specifically advocate a more widespread and nationally coordinated strategy on Covid-19.
All in all, then, Yellen represents one of Biden’s more encouraging appointments. She appears to understand that we can’t go back to the old ways of growth and must therefore resist the seductive idea that the old normal was a good normal. Like the president-elect himself, Yellen must remain open to creatively addressing the economy’s long-term structural challenges unhampered by old shibboleths as she takes on the formidable task before her in the years ahead.