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James Hamilton on the Fed Succession: Why Obama Should Pick Yellen: Noted for August 4, 2013

That's not something he tells us.

James Hamilton:

Why Obama should pick Yellen to lead the Fed: Yellen was one of the first Fed officials to see the problems developing in the US housing market. In late 2005, for example, when she was president of the San Francisco Fed, she explained her concerns about the housing market. “If house prices fell,” she warned, “the negative impact on household wealth could lead to a pullback in consumer spending. Certainly, analyses do indicate that house prices are abnormally high – that there is a ‘bubble’ element.”… Yellen was also one of the people who saw most clearly the magnitude of the problems facing the economy as Prof Rajan’s predicted financial disaster began to unfold. Her speech to the National Association for Business Economics in 2007, when reread today, strikes the reader as amazingly prescient. Many Fed officials at the time felt that, since the subprime mortgages represented only 10 to 15 per cent of all mortgages, problems with these loans would not be enough to cause major economic damage. But Ms Yellen noted that the complex system of derivative instruments linked to subprime mortgages, such as collateralised debt obligations and credit default swaps, could lead to great uncertainty among lenders about the vulnerability of particular borrowers and a devastating withdrawal of credit. Yellen further emphasised that the mathematical models companies had used to evaluate the risks of those instruments took insufficient account of the consequences of a significant downturn in house prices. Again, her assessment proved to be right on the mark.

Yellen has also been a leader among Fed officials in recognising that the economic recovery that began in 2009 would be disappointingly slow and continue to need assistance from the Fed. Its programme of quantitative easing, of which Ms Yellen has been a key supporter, is not without some controversy. There were many analysts who predicted that these policies would produce runaway inflation. But the inflation rate in the past four years has been the lowest since 1966. So far, at least, the critics have been proved wrong – and Ms Yellen right….

She has a very impressive intellect but does not feel a need to show it off. Instead, she has an amazing knack for always asking the right questions. If someone disagrees with her, her first instinct is to try to understand why they have reached a conclusion different from her own. For this reason, Ms Yellen is one of the people I would most trust to find out what the key problems are and what needs to be done in any new situation. But her intellectual openness should not be construed as a lack of toughness. Precisely because she has a gift for analysing the situation very clearly, she is also very committed to following through on what she perceives to be the appropriate policy.

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