01/22/2014 12:41 am ET Updated Mar 24, 2014

What's All the Yellen About?

As Janet Yellen prepares to take over from Ben Bernanke as head of the Federal Reserve, speculation is rife about how this change will affect monetary policy. Financial markets are twitching in anticipation of the next few meetings of the Federal Open Market Committee (FOMC), which determines monetary policy.

For all the Yellen-watching going on, it is important to remember that the changeover is likely to be pretty subtle, especially at first. There are three reasons for this:

  1. The Fed decides monetary policy as a group. There are 11 members of the FOMC, so it's more like a big band than a solo act. The bandleader is important, but not more important than the sum of the other parts.
  2. Yellen is a Fed insider. As vice chair of the Fed since 2010, Yellen has co-piloted monetary policy in recent years. Off and on, she has been involved with the Federal Reserve System since 1994.
  3. Markets also have a hand in interest rates. The Fed is at least as much influenced by the financial markets as the markets are by the Fed.
In short, as curious as everyone is about Yellen, don't expect any shocking revelations right off the bat.

Judging a Fed chair's legacy takes time

It will take time to gauge what kind of Fed chair Janet Yellen is. The stock market may be prone overreact to the pace at which Yellen's Fed tapers back quantitative easing, while the FOMC might continue to walk on eggshells as it tries to implement policy without upsetting the market. However, her unwinding of an existing initiative will not reveal much about her; only as new monetary initiatives appear, or perhaps when the next crisis emerges, will Yellen's wisdom, creativity and resolve really be tested.

Indeed, even as Bernanke walks out the door, it is still too early to judge his legacy. After all, when Alan Greenspan left the Fed after serving as chairman from 1987 through 2006, he was generally highly regarded. The economy had seen only two recessions on his watch, both of them mild, and both the stock and housing markets were flourishing. Only in the years that followed did it become apparent that the Fed had failed to appreciate the mounting instability of the financial system, and that it had helped enable bubbles in stocks and housing that were bound to burst.

As for Bernanke, the appearance upon his leaving is that he acted creatively and effectively by instituting bond purchases to drive long-term rates down, helping to stabilize the economy and the housing market. However, those very same policies leave troubling questions: Will record highs in consumer debt -- enabled by low-interest rates -- lead to a new wave of defaults? Will the recoveries in the stock market and real estate prove to be overly dependent on unnaturally low-interest rates? What will happen to retirees whose incomes have been destroyed by low savings account rates? Will inflation remain docile enough to allow for an orderly unwinding of the low-interest-rate policy?

It turns out that for all the speculation about what type of Fed chair Janet Yellen will be, just like with Ben Bernanke, her legacy may be largely determined by how she plays the hand that her predecessor dealt her.