A few days ago we witnessed the first statement given by Janet Yellen, the new Chairman of the Federal Reserve (Fed), before the US Congress. The message inferred from her words that Ben Bernanke's legacy would be continued, especially in terms of interest rates, was warmly welcomed by investors and reflected in stock market gains. However, and although both dignitaries have unconditionally supported the largest monetary expansion in the Fed's history, the changeover is taking place in an economic context that had not occurred during Bernanke's mandate.
The US economy is now at a turning point (from crisis to recovery) whose solidity could generate a range of opinions within the Fed. During the exceptional times of the past crisis, most central bank officials opted for a dovish approach (more inclined to relax or less inclined to restrict given the same scenario) instead of hawkish (the opposite of the former). But with the economy's gradual improvement, the different Fed officials will return to their more genuine profiles (dovish or hawkish, depending on each one's preference) and this is when we will see Yellen's stance and ability. Bringing together the different opinions within the Fed and convincing the markets of the logic of the «exit strategy» that will be followed by the institution in the near future will be the key challenges facing the first woman to head this century-old institution.
This will certainly be no easy task. In June 2013, the mere announcement of a possible start to tapering (reduction in the pace of its asset purchases) caused much commotion in the markets, especially in the emerging economies whose currencies underwent sharp depreciations. And although the real start to tapering in December 2013, still under Bernanke's chairmanship, did not result in the same agitation, most of the exit strategy actions will fall under Yellen's mandate and no-one is sure of their impact on the markets.
The key to avoiding too much volatility in the markets lies in forward policy guidance. This must form the cornerstone to the withdrawal of the ultra-easy monetary policy of the last few years. In this respect, the appointment of Janet Yellen has been positive as she is a firm defender of the need to improve and innovate the Fed's communication policy. In 2010 she was appointed Chairman of the recently created subcommittee on communications of the Federal Open Market Committee (FOMC) and in January 2012 the very first Statement of Longer-Run Goals and Policy Strategy was presented, representing a huge step forward in the transparency of its goals and strategies. In Yellen's own words, «[...] clear communication is itself a vital tool for increasing the efficacy and reliability of monetary policy».
However, the clarity endorsed by the new Chairman was somewhat sullied by her own appearance before Congress (as also happened to Mark Carney, governor of the Bank of England). Although linking the end of accommodative policy to developments in a few variables in the real economy (the unemployment rate and medium-term inflation) has been effective while the economy failed to pick up, progressive improvement in economic activity has highlighted the fact that the recovery is not always reflected evenly across all variables. While the unemployment rate has been steadily improving and is now very close to the target set by the Fed (6.5%), according to Yellen the recovery in the labour market is still «incomplete».
In a complex reality, forward guidance must improve in order to remain effective. The markets must be able to understand it perfectly and believe in it. In particular, it is vital to avoid any impression of the Fed adjusting, to suit its own ends, the determining factors established for its monetary policy decisions.