Commentary Magazine


Topic: Federal Reserve

Janet Yellen

President Obama is nominating Janet Yellen for the post of chairman of the Board of Governors of the Federal Reserve, perhaps the world’s most powerful financial position.

The media, with its obsession with firsts for minorities, will doubtless make a big deal of her being the first female chairman (women actually make up a majority of Americans, but never mind that).

More to the point, she is spectacularly well-qualified for the job. She graduated, summa cum laude, from Brown with a degree in economics and got her Ph.D. in the subject from Yale four years later. She has been an economics professor at both Harvard and Berkeley, worked as an economist in the division of international finance at the Fed, served as chairman of the White House Council of Economic Advisors under President Clinton (and at the same time was chairman of the Economic Policy Committee of the Organization for Economic Cooperation and Development), been a Federal Reserve governor, served as president of the Federal Reserve Bank of San Francisco, and been vice chairman of the Fed for the last three years. Oh, one more thing, her husband, George Akerlof, won the Nobel Prize in economics in 2001.

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President Obama is nominating Janet Yellen for the post of chairman of the Board of Governors of the Federal Reserve, perhaps the world’s most powerful financial position.

The media, with its obsession with firsts for minorities, will doubtless make a big deal of her being the first female chairman (women actually make up a majority of Americans, but never mind that).

More to the point, she is spectacularly well-qualified for the job. She graduated, summa cum laude, from Brown with a degree in economics and got her Ph.D. in the subject from Yale four years later. She has been an economics professor at both Harvard and Berkeley, worked as an economist in the division of international finance at the Fed, served as chairman of the White House Council of Economic Advisors under President Clinton (and at the same time was chairman of the Economic Policy Committee of the Organization for Economic Cooperation and Development), been a Federal Reserve governor, served as president of the Federal Reserve Bank of San Francisco, and been vice chairman of the Fed for the last three years. Oh, one more thing, her husband, George Akerlof, won the Nobel Prize in economics in 2001.

But, of course, résumés aren’t everything. The Federal Reserve’s most important job is to maintain the value of the dollar while keeping unemployment low. Those are often contradictory goals and the political pressures from sound-money advocates on one side and easy-money advocates on the other can be intense. Janet Yellen has a reputation for favoring soft-money policies and low interest rates. Rates have been very low in recent years to spur recovery from the recession, but at some point the Fed will have to begin to tighten or inflation will explode. It will also have to begin pulling back in some of the trillions of dollars it has created in recent years. It has recently been buying $45 billion in federal bonds and mortgage-backed securities a month, paying for them with newly-minted dollars.

Also, she will have to convince the other members of the Fed’s Open Market Committee to follow her lead. The Open Market Committee consists of the seven members of the Board of Governors plus the presidents of five of the 12 regional Federal Reserve banks. One seat is reserved for the president of the New York Fed, the other four rotate among the 11 other banks. It is the main decision-making body at the Fed. The chairman must get its agreement to act.

Barring some unexpected development, she will win Senate confirmation, probably losing only a few Republican votes. Then the tough part begins. I do not envy her.

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The Fed Stands Pat on the Stimulus

In a bit of a surprise, the Federal Reserve’s Open Market Committee voted 11-1 to continue its program of buying $85 billion worth of federal and mortgage bonds in order to continue stimulating the economy. It had announced in June that it would begin cutting back on these purchases by the end of the year and many expected it to begin doing so today. 

Both Paul Krugman who wrote earlier this week, “Memo to the Fed: Please don’t do it” and the financial markets, which love low interest rates, are happy. The S&P 500 index hit a new high on the news.

By buying these bonds, the Fed is, in effect, creating money, almost $1 trillion a year in new money. Since the financial meltdown in 2008, the Fed has created many trillions of dollars trying to stabilize the economy and then revive it. At some point it will have to begin to reduce and then reverse its bond purchases and get that money back into its capacious vaults lest a virulent inflation break out.

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In a bit of a surprise, the Federal Reserve’s Open Market Committee voted 11-1 to continue its program of buying $85 billion worth of federal and mortgage bonds in order to continue stimulating the economy. It had announced in June that it would begin cutting back on these purchases by the end of the year and many expected it to begin doing so today. 

Both Paul Krugman who wrote earlier this week, “Memo to the Fed: Please don’t do it” and the financial markets, which love low interest rates, are happy. The S&P 500 index hit a new high on the news.

By buying these bonds, the Fed is, in effect, creating money, almost $1 trillion a year in new money. Since the financial meltdown in 2008, the Fed has created many trillions of dollars trying to stabilize the economy and then revive it. At some point it will have to begin to reduce and then reverse its bond purchases and get that money back into its capacious vaults lest a virulent inflation break out.

The timing will be tricky, to put it mildly. Too quickly and it could throw the economy back into recession. Too slowly and we could be back to the 1970’s, with double-digit inflation.

Let’s hope they get it right.

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Get Ready for Obama’s Great Recession

As John Steele Gordon rightly points out, Ben Bernanke’s latest attempt to bail out a failing economy by manipulating interest rates isn’t likely to be met with any more success than his first two tries. Some Democrats may think the Federal Reserve’s decision to print more money will inflate the economy enough to get President Obama re-elected. The assumption is that it will cause a rise in the stock market that will be interpreted as a sign that the recovery has finally succeeded. However, the result of another dose of inflationary economics, compounded by growing debt, unemployment and less than 2 percent growth may be another recession that will come on the heels of the current anemic recovery.

The constant refrain coming from the administration and its defenders has been that a change of course away from the president’s reliance on trying to spend our way out of the economic ditch would be a return to the failed Republican policies of the past that created the problem in the first place. But as James Pethokoukis writes at the American Enterprise Institute blog, it is cheap money and too much debt that caused the so-called Great Recession that the president inherits. That recession ended in the summer of 2009. It was followed by a recovery for which the president once took credit. But the feeble nature of that revival is something he still blames on his predecessor. Thanks to the continuation of the spending and debt binge that took place over the last four years, the country may soon be faced with another Great Recession no matter who wins in November. But it is not likely that most Americans will be willing to blame that one on George W. Bush.

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As John Steele Gordon rightly points out, Ben Bernanke’s latest attempt to bail out a failing economy by manipulating interest rates isn’t likely to be met with any more success than his first two tries. Some Democrats may think the Federal Reserve’s decision to print more money will inflate the economy enough to get President Obama re-elected. The assumption is that it will cause a rise in the stock market that will be interpreted as a sign that the recovery has finally succeeded. However, the result of another dose of inflationary economics, compounded by growing debt, unemployment and less than 2 percent growth may be another recession that will come on the heels of the current anemic recovery.

The constant refrain coming from the administration and its defenders has been that a change of course away from the president’s reliance on trying to spend our way out of the economic ditch would be a return to the failed Republican policies of the past that created the problem in the first place. But as James Pethokoukis writes at the American Enterprise Institute blog, it is cheap money and too much debt that caused the so-called Great Recession that the president inherits. That recession ended in the summer of 2009. It was followed by a recovery for which the president once took credit. But the feeble nature of that revival is something he still blames on his predecessor. Thanks to the continuation of the spending and debt binge that took place over the last four years, the country may soon be faced with another Great Recession no matter who wins in November. But it is not likely that most Americans will be willing to blame that one on George W. Bush.

Bernanke’s third chorus of interest rate cuts is a last-ditch attempt to save Obama’s recovery. But we may look back on it next year as the moment when the next Great Recession became inevitable. In the long run, only a program that aims to reform our out-of-control spending, tax cuts to fuel real economic growth and to create wealth, and sound money policies from the Fed will create a genuine recovery.

But a steady diet of more spending, debt and cheap money has set the stage for a transition from a weak recovery to another collapse. Indeed, the bad employment numbers show that the recovery never reached some sectors of the economy or the army of unemployed Americans. That means that for many Americans the downturn we may have to face next year will feel more like the tail end of a double dip recession than a fresh downturn.

President Obama is hoping Bernanke’s latest stunt will give him the boost he needs to stay ahead of Mitt Romney in the final weeks of the campaign. But the long-term impact of the Fed chairman’s QE3 may merely pave the path for a poor economy that will make a second term a misery for both Obama and the American people.

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Bernanke’s Hammer

It’s an old saying that if your only tool is a hammer everything begins to look like a nail. Ben Bernanke, the Chairman of the Federal Reserve Board, has now decided to take a third whack at unemployment by another round of “quantitative easing,” using “open market operations” to manipulate interest rates.

In March 2009, the Fed launched a $1.25 trillion program to buy up mortgage backed securities in hopes of jump-starting the economy. This massive injection of liquidity into the economy certainly helped the stock market (which bottomed that month) and stabilized the economy. The second bout of qualitative easing, however, in November 2010, when the Fed began buying $600 billion in treasuries, had far less effect. Will this one help? The promise to buy $40 billion of mortgage-backed securities a month for the indeterminate future has already sent stocks soaring around the world, but anything that tends to lower interest rates and increase the money supply sends investors out of bonds and dollars and into commodities and stocks. The theory is that higher stock prices will have a “wealth effect,” making people think they’re richer and therefore more willing to spend money. But since the move is likely to make commodities costs more (both oil and gold rose yesterday) it’s at best doubtful that it will work.

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It’s an old saying that if your only tool is a hammer everything begins to look like a nail. Ben Bernanke, the Chairman of the Federal Reserve Board, has now decided to take a third whack at unemployment by another round of “quantitative easing,” using “open market operations” to manipulate interest rates.

In March 2009, the Fed launched a $1.25 trillion program to buy up mortgage backed securities in hopes of jump-starting the economy. This massive injection of liquidity into the economy certainly helped the stock market (which bottomed that month) and stabilized the economy. The second bout of qualitative easing, however, in November 2010, when the Fed began buying $600 billion in treasuries, had far less effect. Will this one help? The promise to buy $40 billion of mortgage-backed securities a month for the indeterminate future has already sent stocks soaring around the world, but anything that tends to lower interest rates and increase the money supply sends investors out of bonds and dollars and into commodities and stocks. The theory is that higher stock prices will have a “wealth effect,” making people think they’re richer and therefore more willing to spend money. But since the move is likely to make commodities costs more (both oil and gold rose yesterday) it’s at best doubtful that it will work.

And how much lower can interest rates go? Mortgage rates were at 3.55 percent on Wednesday, down from 4.09 a year ago. That’s the lowest rate for a 30-year fixed rate mortgage in memory. The ten-year treasury bond is paying a piddly 1.86 percent. Interest rates cannot go below zero, after all. Banks won’t pay you to borrow their money.

And all this is storing up big trouble in the future. The Fed has increased its balance sheet enormously by buying up assets and, in effect, printing the money to pay for them. Getting that money back is going to be very, very difficult to accomplish without slowing the economy once again or setting off a nasty bout of inflation.

Sometimes the best thing to do is nothing. Unfortunately, it is very difficult for politicians (and while Bernanke is not, strictly speaking, a politician, it’s close enough for government work) to do nothing.

 

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