Bloomberg is reporting today that Janet Yellen is President Obama’s pick to succeed Donald Kohn as vice chairman of the Federal Reserve. Yellen is currently the President of the San Francisco Fed, the largest of the 12 Federal Reserve Districts, both geographically and economically.

Yellen is an excellent selection for the post. She recognized the looming crisis earlier than anyone else on the Fed. A graduate of Brown and Yale, she has taught economics at Harvard and Berkley and served as the Chair of the Council of Economic Advisors under President Clinton. She is also married to a Nobel Prize-winning economist (just imagine the pillow talk about the money supply).

In her role as vice chair, she would always have a vote on the open market committee. As President of the SF Fed, she rotates onto the committee and is a voting member every three years (she was a voting member last year).

From her recent speeches, it is clear that she is inclined to keep monetary policy accommodative for the next year or so. She understands that the major threat facing the economy right now is low growth and high unemployment, not runaway inflation.

She is also one of the tougher regulators (OK, this is seriously grading on a curve) of the major Fed figures. Replacing Kohn will fill only one of three vacancies on the Federal Reserve Board. It is a mystery as to why the Administration has not even named candidates for the other two spots, which have both been open for almost a year now. It is the economic equivalent of leaving two slots on the Supreme Court unfilled (although these are not lifetime appointments).

Keeping Fed Funds Rate Low

Keeping the Fed Funds rate low is needed right now given the enormous amount of slack in the economy. The two key measures of this are the unemployment rate — which on an “official basis” (U-3) stands at 9.7% — and people who have been involuntarily cut back to part-time status or are otherwise under-employed are factored in (U-6) stands at 16.8%.

Capacity utilization is currently at 72.6%; 80% is more normal. Under such conditions, runaway inflation is unlikely to be a major problem. There is simply no way for the wage side of a wage-price spiral to gain any traction.

A low Fed Funds rate will also keep the yield curve very steep. This is very good news for the banks, as one of their core economic functions is to borrow short (for example, take in checking deposits which can be withdrawn at any time) and lend long (say, a mortgage or a commercial term loan). The steeper the curve; the greater the margin.

This is allowing banks like Wells Fargo (WFC) and even Citigroup (C) to earn their way back to health. Since banks have cut back on dividend payments and share repurchases (ordered, too, in the case of the TARP banks, strongly encouraged to by the regulators by smaller banks), this has allowed banks to rebuild their depleted capital.

While the report has not been confirmed by the White House yet, if true this is an excellent choice. The Administration should move quickly to fill the remaining two spots with people of equal quality.
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