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Janet Yellen's cautious retreat from zero-rate era

With the Federal Reserve's hiking short-term interest rates by a quarter-percentage point, a cautious Janet Yellen has taken the final step to unwind her crisis-manager predecessor's extraordinary economic rescue operation.

During her almost two years chairing the Federal Reserve Board, Yellen has phased out the two signature stimulus policies enacted under Ben Bernanke: a massive purchase of long-term bonds and mortgage-backed securities, known as quantitative easing; and a move since the Great Recession to hold short-term rates near zero.

A labor economist who worries about many Americans' still-precarious financial condition, she has been in no rush to end that stimulus, taking care to satisfy herself that the economy could cope with the Fed's withdrawal of "easy" money.

Federal Reserve raises interest rates 0.25%

The bond-buying program was launched in 2009 to hold down long-term rates, such as for mortgages and corporate lending, spurring home buying and business spending. Yellen shut down this effort late last year. Keeping shorter-term rates at almost zero has been in effect since the end of 2008. Both initiatives were to prop up an economy savaged by the financial crisis.

Before the Fed ended them, Yellen, 69, made sure to signal her plans to the capital markets, so no one was surprised. Nevertheless, her primary consideration always was that the Fed shouldn't act until economic data showed it was safe.

Many on Wall Street expected the Fed to increase rates at its September meeting. But the central bank backed off, worried about plunging oil prices' impact on growth, as well as the slowdown in China, the world's No. 2 economic power.

While her prudence seemed unwarranted to some, Yellen has said she wanted to be sure the economy wouldn't suffer from premature removal of its monetary intravenous feed. She has been leery that higher rates will choke off the nation's halting economic recovery. In May, the Fed chief told a forum in Washington that the board worried about "a sharp jump in long-term rates" after the Fed acts.

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At her press conference Wednesday following the announcement of the rate increase, Yellen acknowledged that "wage growth has yet to show sustained pickup." She stressed that monetary policy remained "accommodative," meaning rates are still historically low and thus shouldn't be a danger to growth.

Yellen, the first woman to lead the Fed, joined the Fed Board of Governors in 1994. She took took time out to head President Bill Clinton's Council of Economic Advisers from 1997-99, then rejoined the central bank as head of the San Francisco Fed. Yellen became vice chair of the Fed in 2010.

In that role, Yellen was a strong backer of Bernanke's stimulus campaign. While they come from different political parties -- President Barack Obama named her to the top Fed job, which she assumed in February 2014 -- she and Bernanke both believed that the Fed had to move decisively to counteract the recession.

The results of their efforts are mixed. On the plus side, stocks and housing have rebounded smartly, and the economy has added 2.3 million jobs this year. Inflation remains tame, although below the 2 percent yearly growth level that Yellen deems the sign of a solid recovery. Banks, which teetered on the brink of oblivion in 2008, are much stronger, in part because the Fed purchased their troubled mortgage securities. Less encouraging is a weak expansion in gross domestic product and persistent sluggishness in wage growth.

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What's of paramount importance to Yellen are the stagnant wages that bedevil Americans below the top income tier. As Paul McCulley, former chief economist at asset manager Pacific Investment Management Co (PIMCO), wrote in 2014: "Bluntly put: Chair Yellen wants labor to get a fairer share of the fruits of the economy's productivity: nominal wage gains greater than inflation -- real wage gains."

Pursuing her Ph.D. at Yale University, Yellen studied under James Tobin, a Nobel laureate who championed Keynesian economics, which holds that government can mitigate downturns. Her thesis focused on employment and its relation to economic growth.

At her press conference yesterday, she noted that the official unemployment rate has made progress: The level is half the 10 percent peak it hit in October 2009. But this sanguine figure masks the unpleasant reality that many people have dropped out of the workforce or are forced to work part-time. It dismays Yellen that the labor force participation rate stands at 62.5 percent, below the 66 percent reading at the end of 2007, when the recession was getting under way.

The result was her caution about lifting rates. To some Wall Street types, that shows Yellen is indecisive. In an October CNBC survey, only 8 percent of economists and money managers gave her an A rating, a steep fall from 36 percent in April.

She has also taken heat from politicians on both right and left. To GOP presidential candidate Donald Trump, Yellen has kept rates low as a favor to Obama because the president doesn't want to have a recession during his remaining time in office. "This is a political thing, keeping these interest rates at this level," the billionaire developer told Bloomberg Television in October. "Yellen is keeping rates too low, too long."

The other side of that argument is that hiking rates while the economy is still fragile risks a repeat of the so-called Mistake of 1937, when the Fed's disastrous decision to raise them smashed the nation's slow recovery during the Great Depression. "The biggest risk we face today is prematurely engineering restrictive monetary conditions," said Chicago Fed President Charles Evans at a conference last year.

Why did Yellen decide to act now? Her answer: prudence. Seeming to channel her 1937 Fed forebears, she said that waiting for inflation to accelerate would force the Fed to "tighten abruptly." And that could lead to a recession.

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