Janet Yellen, new Chair of the Federal Reserve, had a hearing before the House Financial Services Committee this morning, and she emphasized her continuity with the Bernanke monetary policy regime. She said that though the Federal Reserve would continue to watch economic indicators closely, it would continue its slow tapering of quantitative easing unless things changed.
While Yellen is obviously incredibly capable and intelligent, the Fed’s passivity in the face of what continues to be an unemployment catastrophe is a huge problem. Indeed, the fact that Yellen herself understands what’s happening so well militates in favor of structural reform to give the Fed new options to fight unemployment. The status quo just isn’t working.
This was a frustrating hearing to watch. On the one hand Yellen evinced a deep understanding of the many issues that have plagued the economy since the financial crisis. She noted that inflation is low, and trending lower, and that is a problem in and of itself. She noted that the official unemployment rate probably underestimates the current amount of economic slack, given broader measures like how many people are working part-time but would like to work full-time. She believes that most of the current economic troubles are cyclical, not structural, given how the prime-working age employment rate has collapsed and other factors. Overall, it was an impressive performance.
However, she reiterated her commitment to continuing the Fed’s current policy of tapering their asset purchases, despite the fact that since they announced the taper the last two job reports have been lousy and emerging markets have been in turmoil. On the one hand you have the most important economic policymaker who seems to understand perfectly that for most people, the American economy has barely recovered at all from the financial crisis, but on the other hand she is pulling back the most aggressive stimulus program she has, and doesn’t propose to replace it with anything. For heaven’s sake, why aren’t we moving heaven and earth to get Americans back to work?
Now, it could be that Yellen is just consolidating her position. She has only been Fed chair for a few weeks, after all. But given the behavior of Ben Bernanke — a scholar of the Great Depression who made his academic career outlining the mistakes countries like Japan made when they got stuck in the zero lower bound sandpit that we are now stuck in, and proceeded to repeat most of those mistakes — I don’t think we’re witnessing a failure of nerve or understanding. I think the Fed has run into political and institutional constraints.
For reasons that remain somewhat obscure, the Fed as an institution is clearly just incredibly uncomfortable with unconventional stimulus, and they’ve been itching and fidgeting and sweating to cut back on quantitative easing as soon as they can. Ironically, this probably backfires, as their obvious eagerness to cut the program erodes its effectiveness by convincing markets that the Fed intends to tighten policy prematurely, which weakens the economy and forces the Fed to keep up their halfhearted stimulus longer to avoid deflation or another recession. I’d bet that this happens again in the next few months.
What the Fed needs is a tool which it can use (or be shamed into using) without getting all anxious and pulling back before full employment is reached. There are a lot of options we might try — a higher inflation target, or NGDP level targeting, or my personal favorite, per capita transfers of free new money. But the point is that our current de facto policy of just stumbling forward on the status quo path will not solve our unemployment crisis anytime soon, maybe ever.