Heads the Fed Wins, Tails You Lose
With the Senate’s recent confirmation, Janet Yellen will soon become the most powerful woman in the world. When she takes over the reins of the Federal Reserve from Ben Bernanke on February 1st, she will become the 15th Fed Chairman and first woman to hold the position. And as I’ve said before, she’s the right woman for the job. At least by the standards set by the position.
Yellen is an ardent supporter of the Phillips Curve, an idea that relates changes in inflation to the amount of slack in the economy. She is a monetary policy “dove”: one who thinks reducing unemployment is more important than halting inflation.
While she might not give the best balancing act to the Fed’s dual mandate of promoting full employment and fighting inflation, at least she considers both. Unfortunately, the Fed’s dual mandate just isn’t what is used to be.
The Quantitative Easing policies enacted under the Bernanke Fed are geared more towards supporting general asset prices than with controlling inflation or supporting employment directly.
Indeed, some Fed officials, like William Dudley from the New York district, have admitted that the Fed does not know how these QE policies work to help the economy. This would be a humbling admission, if it were true. Actually, there is quite a bit of evidence available to Fed economists that says QE is counterproductive and harmful to growth. And this evidence is not just from Austrians warning of the dangers of promoting further malinvestments and stopping those already made from being remedied. Evidence also abounds from mainstream economists.
Robert Hall warned last August at a Fed conference in Jackson Hole that QE is responsible for a buildup in reserves which contracts the economy. He also commented that the attention on new central banking tools, such as forward guidance and GDP targeting, are misplaced and that attention should be given to building up bank capital. (Perhaps by increasing reserves to, say, 100% of the deposit base?)
Hyun Song Shin of Princeton University found that QE has had no effect on non-corporate lending, which is troubling since small businesses are the engine of growth in the economy. Arvind Krishnamurthy of Northwestern and Annette Vissing-Jorgensen of UC Berkeley (where Janet Yellen is Professor Emerita) found that while QE may have provided minor support to asset-backed securities, this small benefit is outweighed by the costs of exiting the program in the future.
In short, it’s not that the Fed doesn’t know what will happen as it continues deeper into uncharted QE territory. It knows full well, but chooses to go anyway.
This all might be troubling for Yellen if she was just taking over the Fed and sticking to its original mandate, or even the expanded one that Bernanke enacted. But the Fed that Yellen takes the helm of is already seeing calls from interests outside of its mandate. Once upon a time economists only worried about central banks remaining independent of government influence. Then with the Bernanke Fed a worry developed that the Fed was being captured (was captured?) by the financial industry to bail it out. Now we see that the Climate Change movement has the Yellen Fed in its sights!
As the Senate confirmed Yellen it had a fairly clear idea of where she stood on the traditional issues that concerned the Fed. Increasingly these are the issues that don’t matter as the Fed moves beyond the original limited mandate of low inflation and full employment.
Janet Yellen might be the right woman for the job, but the job is not the right one for the economy. What’s in store is more of the same – expansions of the Fed’s control over not only the economy, but other further-reaching aspects of our lives. (Cross posted at the Ludwig von Mises Institute of Canada.)
Photo credit: coolmikeol