Janet Yellen’s confirmation as Federal Reserve chair could be dicier than initially anticipated if the U.S. economy continues to sag and an end to the Fed’s easy-money stimulus policies recedes further into the horizon.
Yellen’s nomination by President Barack Obama on Oct. 9 to succeed current Chair Ben Bernanke was hailed as historic and her confirmation hearings before a Senate committee later this year widely predicted as a cakewalk.
That might not be the case (even if you put aside that Sen. Rand Paul on Friday said he may try to block Yellen's nomination.) With each new lackluster economic report the question of when and how the Fed will begin scaling back stimulus grows more muddled, providing Yellen’s opponents with more leverage to use the confirmation hearings as a broader referendum on the Fed’s activist role under Bernanke.
Yellen has been one of Bernanke’s biggest supporters and is expected to at least maintain – if not accelerate – his policies.
Instead of the predicted confirmation cakewalk, given the sustained economic malaise, Yellen could now be called upon not only to defend the Fed’s past policies, but also to justify why they should be maintained and, perhaps most importantly, how they will eventually be phased out without causing additional harm to the recovery.
“The first question asked should be, ‘For $85 billion a month, what are we getting?’”
- Mark Williams, former Fed examiner
The anemic September jobs report released Tuesday, which revealed just 148,000 jobs were added last month, pounded home two points, both of them relevant to Yellen’s nomination to succeed Bernanke early next year.
The first is that the economic recovery -- such as it is -- is stagnating rather than gaining momentum. Labor markets continue to struggle as a range of uncertainties from fiscal policy to new health care laws dampens hiring. The housing recovery has also shown signs of weakness due to rising mortgage rates.
The second point is that the Fed will be increasingly reluctant to take its foot off the stimulus gas pedal as long the economic data continues to disappoint.
The latter is what could make Yellen’s nomination hearing more combative than previously forecast.
“I think there will be more resistance to her as the economic numbers continue to come in weak,” said Mark Williams, a former Fed examiner who now teaches banking at Boston University.
Williams said the weak economic data of late will require Yellen to answer a key question: if there are legitimate doubts about whether the Fed’s stimulus policies are working, why should they be continued indefinitely?
“The first question asked should be, ‘For $85 billion a month, what are we getting?’” said Williams, referring to the Fed’s $85 billion a month bond purchase program called quantitative easing.
“We’re pushing billions of dollars into the system and only getting millions out,” he added. “Growing economic data is showing that (quantitative easing) on its own isn’t going to get our economy back on track.”
Stock Markets “A Table on One Leg”
The Fed had hinted all summer that it would begin scaling back bond purchases in September, but then balked when data began showing a weakening recovery.
Now it’s anyone’s guess when tapering might begin.
Critics of the Fed’s unprecedented activist policies in the wake of the 2008 financial crisis believe monetary stimulus, if left unchecked, will eventually invite runaway inflation. Pumping billions of dollars of cash into the economy each month via bond purchases combined with near-zero interest rates will eventually push prices dangerously higher, the critics argue.
A related concern tied to all that free-flowing money is the threat of asset bubbles, a fear some say is already a reality citing the soaring stock valuations.
Williams described U.S. stock markets as “a table on one leg – quantitative easing. When the leg is gone the market will fall.”
Despite the weak economic data, less-than-stellar third quarter earnings and the disarray in Congress that shut down parts of the government for over two weeks earlier this month, the Dow Jones Industrial average and the S&P 500 are hovering at all-time highs.
Stock market investors have gorged on Fed stimulus money for over four years now and have repeatedly resisted any hint of tapering, creating a surreal situation in which markets rally on lousy economic data because the bad news reduces the likelihood of imminent Fed tapering.
It happened again on Tuesday with the release of the disappointing September jobs report.
“There’s something perverse about that kind of market reaction,” said Jeffrey Bell, policy director at American Principles Project (APA), a conservative policy group that opposes Yellen’s nomination. The APA has opened a web site called NoOnYellen.com.
Regulatory and Monetary Policy at Odds
Bell said the upside-down response by investors to poor economic data illustrates a larger point related to Fed stimulus: easy money supplied by quantitative easing and near-zero interest rates will encourage risky behavior by investors, the same behavior the Obama administration and Congress has tried to curb through myriad regulations – notably the Dodd-Frank banking reform bill -- on the financial industry since the 2008 crisis.
In sum, the two approaches – easy money and regulations meant to contain risk – work against each other.
The new regulatory environment, primarily supported by Democrats, “is self-defeating if it comes with easy money,” said Bell. “It encourages the very thing that Dodd-Frank and other regulatory approaches are meant to discourage.”
On the other hand, Bell, noting the partisan nature of the stimulus debate, said Yellen’s supporters – fiscal doves -- will undoubtedly use the stagnant economy as an argument for maintaining easy money.
And, besides, it’s clear Yellen has the support of enough Democratic senators for confirmation.
Nevertheless, Bell believes the Yellen confirmation hearings are an opportunity to give voice to the concerns of the fiscal hawks, providing a platform for a well-publicized debate on the merits of long-term stimulus.
The recent numbers will make that debate that much more compelling.