What’s the Best Way to Stop Creating Jobs?

WASHINGTON, DC - NOVEMBER 14: Nominee for the Federal Reserve Board Chairman Janet Yellen leaves after her confirmation hearing November 14, 2013 on Capitol Hill in Washington, DC. Yellen will be the first woman to head the Federal Reserve if confirmed by the Senate and will succeed Ben Bernanke.
National Journal
Catherine Hollander
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Catherine Hollander
Feb. 11, 2014, midnight

Janet Yel­len has a lonely prob­lem: While the rest of Wash­ing­ton fights to start an eco­nom­ic stim­u­lus pro­gram, the new Fed­er­al Re­serve head is tasked with shut­ting one down.

Her task is a daunt­ing one. The Fed has long prom­ised to wind down its re­ces­sion-era stim­u­lus blitz, but if it goes too quickly, the cent­ral bank could drop the bot­tom out from un­der a still-shaky eco­nomy. And if it goes too slowly, the Fed risks put­ting the eco­nomy on course for an­oth­er crisis.

But however Yel­len plans to make it work, she’s go­ing to have to ex­plain her­self — fast. Just eight days in­to her four-year term as head of the Fed, Yel­len heads to Cap­it­ol Hill Tues­day to ar­tic­u­late her vis­ion to the GOP-led House Fin­an­cial Ser­vices Com­mit­tee.

First up on Yel­len’s to-do list: What to do with a bond buy­ing pro­gram that has been un­der­way since Sep. 2012. The Fed began “taper­ing,” or slow­ing down the pace of as­set pur­chases, in Decem­ber. After two months of $10 bil­lion cuts, the cent­ral bank is cur­rently pur­chas­ing $65 bil­lion each month to shore up the eco­nomy. The goal of the bond buy­ing pro­gram, known as quant­it­at­ive eas­ing, is to bring down long-term in­terest rates and spur eco­nom­ic growth. But it could gen­er­ate fin­an­cial in­stabil­ity (a bubble) or in­fla­tion if it goes on for too long, a con­cern of­ten voiced by con­gres­sion­al Re­pub­lic­ans.

Know­ing when “too long” is reached is a chal­lenge for mon­et­ary poli­cy­makers. In­fla­tion is cur­rently in check, but the last few months of eco­nom­ic data have presen­ted con­fus­ing sig­nals about the re­cov­ery’s strength, made fuzzy by weath­er in­ter­fer­ence. Yel­len is ex­pec­ted to re­it­er­ate in testi­mony that the cent­ral bank will be look­ing closely at the data when it de­cides wheth­er to con­tin­ue taper­ing when the policy-set­ting com­mit­tee meets again in late March. She may also em­phas­ize a longer view, in­dic­at­ing the Fed sees strength be­low the re­cent choppy num­bers. “I think what she’ll point to is [the Fed’s poli­cy­makers] genu­inely be­lieve the un­der­ly­ing fun­da­ment­als of the eco­nomy are im­prov­ing,” said Richard Moody, chief eco­nom­ist at Re­gions Fin­an­cial Cor­por­a­tion.

Even­tu­ally, the end of bond-buy­ing will cause mort­gage rates and oth­er long-term in­terest rates, like those for cars and stu­dent loans, to rise. But Mark Ham­rick, Wash­ing­ton bur­eau chief for Bankrate.com, said after the Fed’s de­cision to cut an­oth­er $10 bil­lion last month that bor­row­ers are un­likely to feel much im­pact of taper­ing for an­oth­er year.

“These are some of the low­est rates that have been seen in gen­er­a­tions sort of across the bor­row­ing spec­trum, and that out­look re­mains prob­ably for the bal­ance of this year,” Ham­rick said. “What hap­pens after that is very much de­pend­ent on what hap­pens with the broad­er eco­nomy.”

An­oth­er key part of Yel­len’s job will be de­term­in­ing and com­mu­nic­at­ing when the cent­ral bank should raise its bench­mark in­terest rate (this is ex­pec­ted to hap­pen after the bond-buy­ing pro­gram has been un­wound). The fed­er­al funds rate, which the cent­ral bank sets and then ripples through in­terest rates across the eco­nomy, has been near zero since Dec. 2008. Like bond buy­ing, the goal of keep­ing the fed­er­al funds rate low is to en­cour­age spend­ing and in­vest­ment to grow the eco­nomy.

And as with bond buy­ing, keep­ing the rate low for too long risks high­er-than-de­sired in­fla­tion. In Dec. 2012, the Fed said it would start to raise the rate some time after the na­tion­al un­em­ploy­ment rate reached 6.5 per­cent. Now, the U.S. job­less rate hov­ers just one-tenth of a per­cent­age point above that level.

But the un­em­ploy­ment rate by it­self is in­creas­ingly viewed as a poor gauge of labor mar­ket health, and few think the Fed is ready to raise in­terest rates in the com­ing months. The job mar­ket is still widely be­lieved to be weak, and the un­em­ploy­ment rate has been on the de­cline at least partly for “the wrong reas­ons” — people leav­ing the labor mar­ket — which, be­cause of the way the job­less rate is cal­cu­lated, ac­tu­ally brings down that head­line num­ber.

Eco­nom­ists are hop­ing Yel­len will give a bet­ter sense Tues­day of when and how the Fed will make the call to raise the fed­er­al funds rate. They might be dis­ap­poin­ted; Yel­len may want to wait un­til the Fed’s next policy-set­ting meet­ing, which is set for March 18-19, and ac­com­pa­ny­ing press con­fer­ence to get in­to spe­cif­ics, pre­fer­ring not to front-run the com­mit­tee she’ll be rep­res­ent­ing be­fore Con­gress this week.

Of course, Yel­len could al­ways be pinned down on something un­ex­pec­tedly in the ques­tion-and-an­swer peri­od with mem­bers of the House Fin­an­cial Ser­vices Com­mit­tee. And law­makers in the oth­er cham­ber will have a chance to fol­low up on Thursday, when she ap­pears be­fore the Sen­ate Bank­ing Com­mit­tee.

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