Economics, Monetary Policy, U.S. Economy

AEI scholars talk Fed, challenges facing Yellen

Image Credit: International Monetary Fund (Flickr) CC

Image Credit: International Monetary Fund (Flickr) CC

Janet Yellen’s confirmation hearing to be the Fed chair is tomorrow. In preparation, let’s look at what the AEI scholars are saying on the Fed and the challenges ahead of Yellen. Issues to watch: slow economic growth, big bank regulation, quantitative easing (QE), and inflation.

In a call this morning, AEI scholars provided questions they would like Yellen to answer tomorrow.

Stephen Oliner:

  • Quantitatively, what does she regard as an acceptable rise in inflation above the target?
  • How much higher could the Fed’s ownership share be pushed before she would view the costs of further QE purchases (in the form of impairing market liquidity or fueling asset bubbles) as being too high?
  • Does she think purchases of long-term assets should be viewed as a regular tool for monetary policy or should they be limited to times when the funds rate is at zero?
  • How far in the future does she believe the FOMC can credibly provide forward guidance about the federal funds rate?
  • What does she think about targeting nominal GDP?

Paul Kupiec:

  • Should the Federal banking agencies be required to formally conduct a cost-benefit analysis and show that new proposed rules and regulations will engender public benefits that outweigh industry and consumer costs?
  • What are her views on the non-bank SIFI designation process?
  • How has the FSOC modified its bank-centric models to fairly assess the systemic risk potential generated by the non-bank SIFIs it has designated?

John Makin warns “Beware the monetary cliff” and provides three suggestions for the Fed and Yellen “to reduce the risk of going over the deflationary monetary cliff”:

 First, the Fed should temper its complacency about the possibility of further disinflation and deflation….

Second, the Fed could underscore its desire to avoid deflation by setting a new target range for inflation with a firmly defined lower bound…. The Fed could highlight its long-run commitment to avoid inflation, along with its desire to avoid deflation, by specifying a target range of around 0.5 to 1.5 percent for inflation.

Yellen’s elevation to the chairmanship of the Fed…presents the Fed’s third opportunity to underscore its commitment to avoid deflation…. By discussing the risk of deflation at some length and by putting a firm floor on the Fed’s willingness to tolerate a drift toward deflation, Yellen could substantially reduce the risks that fears of deflation could produce. Avoiding a self-reinforcing deflationary spiral should be a clearly articulated objective of the Yellen Fed.

Stephen Oliner says Yellen “will have the daunting task of engineering a return to more normal policies after five years of crisis”:

One of the toughest [decisions] will be how long to continue purchasing government securities under the quantitative easing program. The Fed already owns more than a third of longer-term marketable Treasury debt and roughly a quarter of the mortgage-backed securities guaranteed by the federal government. If the current pace of purchases continued until the end of 2014, the Fed could own close to half of the outstanding longer-term Treasuries and about a third of federally guaranteed mortgage-backed securities. By removing such a large share of these securities from circulation, the Fed would run the risk of impairing the operation of these crucial markets and of fueling bubbles by pushing investors to hold riskier assets.

The next Fed chairman will also need to deal with a problem that goes beyond economics: How to communicate effectively with the public. [Bernanke’s] goal was to make Fed policy more transparent and more predictable…. But this effort has not been fully successful.

Abby McCloskey writes we have “A Fed in crisis”:

The Fed is facing economic and capacity crises. The so-called “taper” is one part of the story. The decision how and when to stop pumping $85 billion into the economy each month has haunted the last half-a-dozen Federal Open Market Committee meetings…. Eventually the economy will have to stand on its own two feet without Fed support. The next Fed chair will get the privilege of sorting out when that happens….

Even more significant, the Dodd-Frank Act made the Federal Reserve the prime supervisor and regulator of financial institutions deemed systemically important. The Fed is the “cop on the beat” against the next financial crisis, supervising the biggest banks’ adherence to a laundry list of new, heightened prudential standards including counter-party exposure limits, liquidity and capital requirements and risk management practices.

The next Fed chair….will be tasked to keep inflation under control, a financial crisis at bay, and employment at normal levels.

The rising stock market shows that the Fed’s easy-money policies are working,” according to James Pethokoukis:

What a central bank can do is boost spending and investment to reach a country’s economic potential, whatever that it is. If the Fed was injecting too much money into the economy relative to the amount of money demanded — creating that unsustainable sugar high — “it would be leading to high inflation, but it isn’t,” says Bentley University economist Scott Sumner….  When a central bank really fails to do its job meeting money demand, you get a Great Depression or Great Recession.

Have the Fed’s easy-money policies worked? The rising stock market is a sign they have, since one way the Fed is trying to boost the economy is by nudging people into higher-returning assets. Granted, the Fed’s QEs and forward guidance have yet to deliver strong or accelerating growth and are inferior to a policy that targets the level of total spending, or nominal GDP, in the economy. But they have probably prevented both a double-dip recession and a continuation of double-digit unemployment of the sort seen in the euro zone, where the central bank has been far less active than the Bernanke Fed.

Also check out this video from John Makin on the three biggest challenges facing the next Fed chair.

Follow AEIdeas on Twitter at @AEIdeas.

One thought on “AEI scholars talk Fed, challenges facing Yellen

  1. Lots of good commentary…what a strange world…the Fed could own half of US debt? And roll over on it permanently—or for so long it will be in the next lifetime before it is sold back to the public?

    Do AEI scholars know what they had just said?

    They have just said the Fed monetized one-half of USA national debt without inflationary consequences…a huge boon for taxpayers…call John Cochrane and tell him can sleep now…

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