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6 Dubious Yellenisms From The Fed Chair's Testimony

May 08, 2014

By Diana Furchtgott-Roth

Federal Reserve Chair Janet Yellen did a masterful job navigating the political shoals of the Joint Economic Committee yesterday. She told liberal Vermont Sen. Bernie Sanders (I-VT) that she shared his concern about the Koch brothers and inequality, and conservative Indiana Sen. Dan Coats (R-IN) that Congress needed to act soon to reduce long-term budget deficits.

But her testimony, and the discussion that followed it, raised a host of serious questions about the role of the Federal Reserve in this sluggish economy. As Chair Kevin Brady (R-TX) told Yellen, her “don't worry, be happy” monetary message might not work. From what I heard, there were at least six issues on which she spoke that made no sense. I'll call them Yellenisms. Each of the six issues, below, is bold-faced.

Most important, will the Fed be able to keep inflation in check at “only” 2%, its target goal, after its massive monetary accommodation?

Yellen testified that the Fed has the tools to move in time to avoid inflation. Carnegie Mellon University professor Allan Meltzer, whose op-ed in the Wall Street Journal forecasting higher inflation appeared on the same day, does not think so. Meltzer wrote: “Never in history has a country that financed big budget deficits with large amounts of central-bank money avoided inflation. Yet the U.S. has been printing money — and in a reckless fashion — for years.” Every Fed chair wants to avoid inflation, but America saw substantial periods of inflation in the 1970s that were difficult to eradicate.

Linked to inflation is the question of asset bubbles. Rep. Richard Hanna (R-NY) asked Yellen about Meltzer's concern that seniors on fixed incomes are taking too much risk in the stock market because they can't get a historic rate of return on their savings accounts.

Yellen, in full “don't worry, be happy” mode, sees no evidence of an asset bubble in equities. Plus, she highlighted the advantages for Americans of low mortgage rates that have served to increase the value of houses, Americans' main asset. True, house prices have gone from underwater to back in the black, as she said. Is this another bubble, especially given the current softness in the housing market? It will take us another few quarters to be sure. Former Fed Chairman Alan Greenspan did not see asset bubbles, but they surfaced and popped anyway.

Meltzer suggested that the Fed is responsible for increased income inequality because upper-income taxpayers own more stocks, which have increased in value due to low returns on savings accounts. Yellen said that she could not deny that interest rates affect the stock market, but the Fed has no stock market target. The admission that interest rates do affect the stock market suggests a bubble, because stock values are dependent on the Fed's low-interest-rate policies. As long as the Fed keeps rates low, stocks will continue to rise as investors seek higher yields.

In response to questions by Vice Chair Amy Klobuchar (D-MN) and Rep. John Delaney (D-MD) about whether inequality slows growth, Yellen said that inequality is pulling down spending and slowing the economy. The theory is that the poor spend a larger share of their income than the rich, so raising taxes on the rich and redistributing these funds to the poor raises growth.

However, income invested by upper-income individuals fuels investment, creating jobs for others. And spending by upper-income consumers creates local employment, at least in the United States. Labor Department data show that the top fifth of income earners was responsible for 52% of all spending on personal household services, and 56% of spending on fees and admission to entertainment. Services and entertainment are local businesses that employ low-wage workers. Taxing top earners will result in lower spending on these categories, and less domestic employment.

If transfers of income from one group to another succeeded in creating economic growth, the fastest-growing countries would be those with the highest top tax rates. But high-tax countries tend to have lower growth rates.

Another important question is the role of forward guidance. Yellen testified: “One important policy tool in recent years has been forward guidance about the likely path of the federal funds rate as the economic recovery proceeds.” Don't worry, be happy. But in March, the Fed abandoned its prior forward guidance rule — that it would end monetary accommodation when the unemployment rate reached 6.5 percent — because of uncertainties in the labor market. The Fed now has no forward guidance.

In its March 14 press release, the Fed stated: “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” That is essentially no guidance. That is one reason why Yellen could not answer Chairman Brady's questions as to when she would raise rates and normalize the Fed's balance sheet. She cannot give an exit strategy because she has none.

The “don't worry, be happy” message continued in Yellen's comments about the limp 0.1% GDP growth rate in the first quarter, which she attributed to the weather. That implies that with the Fed's 2014 GDP forecast growth rate at 2.8% to 3%, GDP growth should be above 3% for the rest of the calendar year. But if the weather is not to blame, this shows that our economic problems are more serious than she realizes.

And there are good reasons not to blame the weather. Personal consumption expenditures grew at a solid 3%, so people were in a spending mood. Residential investment declined by 6%, but at a lower rate than the fourth-quarter decline of 8%. Exports of goods declined by 12%, suggesting that the economies of our trading partners — slowness in Asia and Europe — might have something to do with it.

“Don't worry, be happy” also applied to the labor force participation rate, which appears to have stabilized at 62.8%, equivalent to levels in 1978. Answering questions from members, Yellen said that the declining rate is driven by retirements, even though young and middle-aged people are also working less. It is positive that the rate is no longer declining, that it appears to have stabilized, because that is consistent with an improving labor force.

However, the labor force participation rate for people ages 25 to 54 is 80.8%, compared to 84.6% at its peak in January 1999. If the labor force participation rate were at 1999 levels, an additional 4.7 million people would be in the workforce.

For Chair Yellen, there's no need to worry about inflation or asset bubbles; the Fed has it all under control. No need to worry about GDP growth (it's just the weather) and labor force participation (it's mostly old folks, and it has stabilized). It's just that pesky inequality that's a problem, and we all know what the solution is to that.

Original Source: http://www.marketwatch.com/story/6-dubious-yellenisms-from-the-fed-chairs-testimony-2014-05-08

 

 
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