Here’s the key quote from Janet Yellen’s prepared remarks for her confirmation hearing to become Federal Reserve chairman: “Unemployment is ... still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve’s goal of 2 percent and is expected to continue to do so for some time.”
The question that statement raises is: Will she pursue higher employment in a way that creates too much monetary stimulus, risking a new bubble-and-bust cycle, or will her approach be just right for job-scarce times?
Ms. Yellen, a longtime Fed veteran, faced probing questions at Thursday’s Senate banking committee hearing – including some from Republicans worried about the risk of inflation or bubbles such as the one in the housing market that helped precipitate the deep recession that began in 2007.
The questions are pertinent. Although Yellen is widely expected to be confirmed to succeed Ben Bernanke at the end of January, she’s preparing to take the reins at an unusually difficult time.
Many central bank watchers see a strong case for optimism about a Yellen-managed economy: They say she has a solid track record as an economic forecaster, she’s not the soft-on-inflation “dove” she’s often painted as, and her concern with stimulating more job growth is well justified by still-high unemployment.
At the same time, Yellen’s tenure at the helm would come after the Fed has already been engaged in several years of unconventional stimulus efforts. Some economists say a succession of so-called quantitative easing (QE) programs have left the central bank with an uncomfortably large portfolio of assets – treasury and mortgage bonds – that will eventually need to be downsized.
Yellen herself said at the hearing that the Fed will need to wind down QE at some point.
Sen. Mike Johanns (R) of Nebraska was among those who worried aloud that this may not go smoothly.
“The economy has gotten used to the sugar you've put out there,” he warned. “That is a ... dangerous thing.”
Critics of the strategy, which has been backed by Mr. Bernanke and by Yellen as the Fed vice chairman, say downsizing the Fed’s bond portfolio could pose a challenge for the Fed’s goal of economic stability – and they argue that the fruits of QE in boosting job growth have been negligible.
Yellen is among many at the Fed who say the bond purchases have helped to keep long-term interest rates low and boost the speed of an admittedly tepid recovery since the recession ended in the middle of 2009.
Senator Johanns pointed to jitters that swept through financial markets earlier this year – merely at word that the Fed might consider buying fewer bonds, not selling off its portfolio – as evidence of the risks inherent in the Fed being a big buyer of Treasury debt and mortgage-market bonds.
Even some Democrats on the banking committee voiced concern.
Joe Manchin of West Virginia, speaking soon after Johanns, said the economy is not only on a sugar high, but “we're going to go into sugar shock pretty soon.”
Still, he used his comment not to oppose Yellen’s nomination, but to point a finger at his own institution. Yellen and her Fed colleagues, he argued, have done their job to try to boost economic growth, and “we have failed miserably as Congress to our job.”
Although Fed chiefs routinely shy away from offering direct advice to Congress on matters unrelated to central bank activities, they sometimes make general points about the role that government fiscal policy can play.
In the confirmation hearing, Yellen said it appears that “fiscal drag” on the economy from federal tax hikes and spending cuts should diminish next year, compared with 2013. This remains to be seen, though, since budget talks for 2014 are still pending on Congress’s to-do list heading into the holiday season.
Although she’s often characterized as one of the “doves” among Federal Reserve policymakers, less concerned about inflation than those in a hard-line camp, Yellen has shown in the past that she’s hardly complacent about the risk of making money too freely available in the financial system.
She noted at the hearing that she’s routinely voted to raise interest rates, alongside other members of the Fed’s policymaking committee, when conditions warrant.
Yellen emphasized that, for now, the economy still looks weak. She described wage growth as “weak or nonexistent” for many Americans.
“I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy,” she said in her prepared remarks to the committee.